RBI slashes key interest rates, here's what it means and does it solve concerns?

Last Updated: Thu, Jun 06, 2019 19:56 hrs

The RBI Monetary Policy Committee on Thursday announced a cut in key interest rates. The RBI's six member monetary policy committee (MPC) unanimously decided to slash repo rates and reverse repo rates.

Members of the MPC committee are Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Governor Shaktikanta Das.

With this update, the policy repo rate (under liquidity adjustment facility) has been cut by 25 basis points or 0.25% to 5.75 percent.

The reverse repo rate has been adjusted at 5.50 percent. The marginal standing facility rate and Bank rate have been fixed at 6 percent.

A Repo rate is the rate at which the RBI lends money to commercial banks. The Reverse repo rate is a rate at which RBI borrows money from other banks.

The central bank also revealed its policy stance and summarised its observations on global and domestic markets. In a major shift of policy stance, the RBI has shifted from a neutral stance to accommodative. RBI Governor Shaktikanta Das when asked what "accommodative" stance meant by reporters during the customary post-announcement press-conference, he explained that rate-hikes were off the table. He did not reveal until when rate-hikes were off, but given the narrative on liquidity it will be sane to assume that this could last at least during the short term.

The announcement made by the RBI on Thursday implies that loans would become cheaper while deposit-holders would get disappointed at the returns they receive from banks. EMIs for car and housing loans should reflect a change, the end interest paid should come down by a huge margin if banks passed on rate-cuts in true spirit.

Are loans getting cheaper?

The Reserve Bank from its previous three MPC meetings has corrected repo rates by 0.75 percent or 75 basis points. Banks, on the other hand have not been swift in transmitting these rate-cuts to their customers.

The Governor agreed that banks had been slow in transmitting rate-cuts, and said it took previously about 4-6 months for banks to do so. "In 2-3 months, the transmission has been 21 bps. Going forward, we expect faster and higher transmissions to happen," he said.

Why the focus on cheaper loans?

"A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern," reads the note from the RBI.

The Reserve Bank, including the governor believe that cheaper loans could have a rub-on impact on consumer demand. The subdued demand has been one of the major reasons cited for a blip in fourth quarter results of many consumer-oriented companies. Major auto stocks in particular have reported of a blip in fourth quarter results attributing it to weaker demand. Two wheeler sales contracted by 20 percent in February.

The RBI too confirmed these assertions in its assessment. It said, "Railway freight traffic growth decelerated. Domestic air passenger traffic growth contracted in March, but turned around modestly in April. Two key indicators of construction activity, viz., cement production and steel consumption, slowed down in April. The PMI services index moderated to 50.2 in May on subdued growth of new businesses."

Farm activity was a major concern in the recently announced GDP numbers for the fourth quarter of fiscal year 2018-19. For the fiscal, the country recorded GDP growth of 6.8 per cent - a low in five fiscal years. Lesser than expected growth in agriculture, forestry, fishing and jobs were reported a week ago by the CSO. Gross Volume added by the agriculture sector grew at 2.9 percent in 2018-19 as against 5 percent in previous fiscal year.

On the factor of job-income growth, it observed, "Nominal growth in rural wages and in organised sector staff costs remained muted".

Muted growth was a concern that resulted into rate-cuts during the previous meet (April'19). This time too, the central bank believes rate-cuts should help achieve better growth.

Keeping in mind the global and domestic economic conditions, the RBI's outlook assessments too were revised. GDP growth for 2019-20 has been revised to 7 percent from 7.2 percent previously. Growth in first half of the fiscal year is estimated at 6.4-6.7 percent. The second half it has is estimated to touch 7.2 - 7.5 percent.

Besides growth, other big concerns such as liquidity or lack of funds, and a sharp slowdown in investment activity remain. The RBI said that liquidity in the system was in a surplus, and it looked forward to executing more open market operations, transactions related to government securities to improve liquidity further.

The Liquidity Issue:

In its note, the central bank said, "Liquidity in the system turned into an average daily surplus of Rs 66,000 crore (Rs 660 billion) in early June after remaining in deficit during April and most of May due to restrained government spending."

The Reserve Bank injected liquidity of Rs 70,000 crore (Rs 700 billion) in April and Rs 33,400 crore (Rs 334 billion) in May on a daily net average basis under the LAF.

It has announced that it would conduct an OMO purchase auction of Rs 15,000 crore (Rs 150 billion) on June 13, 2019.

In the event of uncertainties resulting from global factors such as trade-wars, tapering economic outlooks in both developing and developed economies and domestic economy cooling to a four year low, a liquidity push was expected from the central bank. That, at least to improve difficulties for housing finance companies and NBFCs. However, there is no direct solution.

The markets crashed soon after the RBI announcement, suggesting a disappointment. At the start of trading session on Thursday, investors had pinned hope thinking liquidity concerns could have been addressed. The markets rallied in the morning session with the Sensex up by 1.4 percent. But, soon after the RBI announcement came out, the Sensex crashed. By the end of trading hours, the Sensex recorded a 553.82 point loss to close the day at 39,529.72.

"Markets were disappointed over the fact that there were no immediate liquidity boosting measures that were announced. Though the RBI has constituted a working group on the same," Deepak Jasani, Head of Retail Research at HDFC Securities, was quoted as explaining.

"Investors were also disappointed over the lower than expected rate cut and on the back of the DHFL default," he added.

Other Concerns:

A weak monsoon and the likelihood of weak El-Nino to continue in the Pacific have been documented by the RBI. Various districts in states of Maharashtra, Tamil Nadu, Gujarat, Andhra Pradesh, Karnataka, Rajasthan, and Odisha have been declared as drought-hit. A water deficit will not only impact farm prices but will also affect markets. Soaring vegetables prices in the unfortunate event of weaker monsoons will impact end-consumers the most.

In its assessment, RBI said, "Moving beyond Q4, the India Meteorological Department (IMD) has predicted that south-west monsoon rainfall (June to September) is likely to be normal at 96 per cent of the long period average (LPA). The current weak El Niño conditions over the Pacific are likely to continue during the monsoon. However, currently prevailing neutral Indian Ocean Dipole (IOD) conditions may turn positive in the middle of the monsoon season and persist thereafter, which augur well for the rainfall outlook."

Deepak Jasani of HDFC Securities says, "The high foodgrains stocks at 72.6 million tonnes as on May 16, 2019 i.e. 3.4 times the prescribed buffer norms gives added comfort on food inflation even if we have a minorly deficient monsoon. The change in the stance to accommodative from neutral and the low growth - low inflation forecast portends possibility of another rate cut in the ensuing meet, unless the monsoon plays truant."

Inflation projections have been raised marginally. In its April announcement, retail inflation was estimated at 2.9-3 percent until September. In its latest update, the CPI inflation has been raised to 3.0-3.1 percent for the first half of the fiscal year keeping in mind various factors and an expectation that rainfalls would be normal.

For the second half, inflation has been projected at 3.4-3.7 per cent.

Here is a video of the RBI press conference post announcement of the MPC results:

The detailed press release can be downloaded in pdf format from here.

Here are some comments/thoughts:

Umesh Revankar, MD & CEO, Shriram Transport Finance: "25 bps cut by the RBI is the third consecutive cut in 2019. The transmission of the previous rate cuts had been very discouraging at only 5-10 bps. As the monsoon predication is very positive, we expected RBI to take a bolder step and do 50 bps rates cut, that would have given clear signal to India Inc to push for growth and take investment decisions thereby maintaining the capex cycle. Because of higher interest rates the consumer spending like auto sales, real estate etc. has been very weak. We urge RBI to open up funding to retail NBFCs through banks that will stimulate the consumer spending."

Zarin Daruwala, CEO, Standard Chartered Bank: "The combination of the repo rate cut, the change to an accommodative stance and the resolve to provide adequate liquidity, will provide the impetus to counter growth and investment headwinds. A review of the liquidity framework is a welcome move and should aid monetary transmission. Additionally, the easing of the leverage ratio requirement will boost bank lending and should serve as the much needed countercyclical stimulus."

Khushru Jijina, MD, Piramal Capital: "NBFCs are instrumental in providing credit to MSMEs and real estate sectors, that are significant to India’s GDP. MSMEs contribute 31% of the GDP, 40% of exports and hires 25% of the labour force while real estate contributes more than 5% to GDP and hires 17% of the labour force directly or indirectly. The credit crunch in the NBFC sector has witnessed a corresponding decline in manufacturing and construction activities in the last two quarters of 2018-19. We anticipate more decisive and pro-active policy measures to address the current liquidity crisis, that will enable NBFCs to restore lending activities, especially to these critical sectors."

Vasu Ramaswami, COO, Muthoot Fincorp: "The latest rate drop should help in improving consumption demand, particularly for the common man, especially once banks decide to pass this rate change to their customers. For the NBFC sector, which has been under some level of tightened liquidity conditions, this should also help in accessing more funds at a cheaper rate, which would eventually help in providing timely credit to millions of their small customers."

B Prasanna, Group Head, Global Markets, Sales, Trading, Research, at ICICI Bank believes that more accomodation is on the cards. He said, "Our own expectations for growth and inflation for FY2020 also underscore this view as we expect headline inflation to average under 4% and have revised our growth forecasts lower. The internal committee for liquidity framework is a welcome step. It will help to reduce the information asymmetry regarding systemic liquidity and will benefit not only markets but also banking decisions as regards, deposit taking, lending and transmission. Further, in light of the recent upheavals in the NBFC space, the Governor’s statement that all necessary steps would be taken to maintain financial stability is reassuring."

Vijay Mansukhani, MD, Mirc Electronics Ltd.(Onida): "We welcome this move of 25 bps rate cut. Rate cut of 50 bps would have been better considering the current liquidity and low consumer sentiment in the market. Moving from neutral to accommodative status is encouraging step from RBI. We hope the economy will grow at better rates in Q2 FY20. The low consumer demand in Q4 FY19 coupled with low GDP has had a negative impact on the companies earnings, we are hoping for better times during the Q2 FY19 onwards."

Sujan Hajra, Chief Economist at Anand Rathi: "RBI carried out the third successive rate cut. Low inflation and subdued growth are the drivers of the move. Yet, the real concern is lack of transmission of rate cuts into effective lending rate. Liquidity conditions also remain tight for large part of the corporate sector. Effective transmission and adequate liquidity remain key challenges."

Garima Kapoor, Chief economist, Elara Capital: "Drawing comfort from consistent softness in inflation trajectory, MPC cut policy repo rate for the third time this year to support benign growth conditions. A shift in the stance to accommodative is welcome as it will pave way for transmission to lending rates, which so far have been inadequate. We expect MPC to cut rates by an additional 50 bps through the year while continuing to fine tune liquidity support through a combination of OMO purchases, forex swap and CRR cut."

Suvodeep Rakshit, Sr. Economist, Kotak Institutional Equities: "RBI reduced repo rate by 25 bps as expected. The change in stance to ‘accommodative’ was a bit of a surprise. Debt markets will take this as a significant positive move though most of the rate cut cycle is probably over. The tone of the RBI policy was dovish and highlights the concerns on growth. We maintain our call for another 25 bps rate cut in August factoring in the benign inflation trajectory and the growing concerns on growth. However, transmission of the rate cuts will be key and the RBI should aim to maintain the liquidity, at least, at neutral over the next few months."

Amar Ambani, President & Head-research, Yes Securities: "In a fairly Dovish policy, the RBI, as we anticipated, not only reduced the Repo rate by 25 basis points, but also changed its policy stance to accommodative, from neutral. More importantly, the RBI has addressed the liquidity crisis in the system with open market operations, turning LAF into surplus in early days of June 2019. It has assured of liquidity support as and when needed. We have factored in another 25-basis point Repo cut in the year 2019 itself."

Ramesh Nair, CEO & Country Head, Jones Lang LaSalle (JLL): "The monetary policy decision to cut the policy rate is laudable. As the residential sector is already at inflexion point signalling a sustainable recovery, this decision will support the trend. This repo rate cut is likely to have a direct impact on the real estate sector, provided the banks, in turn, transmit the same by a corresponding reduction in lending rates. It has been observed that, despite 50 bps reduction in repo rates by RBI in the previous two reviews, the mortgage interest rate has remained sticky. As a result, the required benefit of the rate cut has not reached the home buyers. However, with regulations reinstating homebuyers’ confidence in the segment, markets witnessed recovery in sales in 2018. Further, in the January-March quarter of 2019, sales grew by 28% as compared to the corresponding quarter in 2018. But commensurate transmission in interest rates will further boost residential sales momentum in 2019. Stronger implementation and continuity of reforms under the second term of the current government will uplift homebuyers’ sentiment."

Shishir Baijal, CMD, Knight Frank: "The first rate cut in the newly elected government's regime is certainly a welcome step, especially for the real estate sector. The benefit of lower policy rate in terms of better credit cost as well as higher liquidity will hopefully be transmitted further by banks to NBFCs as well as home buyers. Also, the change in policy stance from neutral to accommodative is a welcome shift as it lays ground for further rate cuts. The cash-crunched NBFCs will definitely benefit from inflow of capital which will in turn benefit developers as well as home-buyers. NBFCs have been facing a liquidity crisis and this has negatively impacted their loans to real estate, including construction finance. Besides capital infusion into this important financier segment, this rate cut will also improve the home-buyers affordability and stimulate housing demand at this critical juncture."

Anuj Puri, Chairman Anarock Property Consultants: "For the housing sector, this rate cut may send only send out positive notional signals - its real gain can be realised only if banks pass on the benefits to actual homebuyer borrowers. The apex bank will need to ensure that this actually happens at the ground level since there has been little evidence of such transmissions in the recent past. In the current scenario bereft with rising NPAs and the ongoing NBFC crisis, things look quite bleak at the moment. The reason why most banks are not really able to pass on the benefits of RBI’s rate cuts is that their deposit rates are still very high. This ultimately makes reducing interest rates to borrowers unfeasible. Nevertheless, this rate cut will only have any really significant impact on the housing market if and when banks reduce their lending rates to homebuyers."

Rajan Bandelkar, President, Maharashtra Naredco: "A good monsoon will lay the context for further rate cuts during the year. The recently revised GST rates coupled with 5.75 per cent and stable government look potentially rewarding with a promising future for home sales in the coming second half of the year."

Parth Mehta, Managing Director, Paradigm Realty: "The stance change from neutral to accommodative by RBI indicates the cognizance about the current fragile business environment and we expect further rate cuts in times to come. Rate cuts shall enable affordability in terms of home loans and thus lowered EMI, lower GST, tax rebate for income up to Rs6.5 lakhs (including section 80C) for the middle class as per as interim budget. All these shall give some sales impetus to real estate."

Rohit Poddar, Poddar Housing & Development: "The reduction in the repo rate is essentially driven by the broad-based deceleration in the economy in recent months. This shows the commitment of the RBI to ensure the transmission of rate cuts to the end consumers. Slashing down the rates by 25 Bps along with a changed stance will create a positive ecosystem and stimulate the growth dynamics and investment cycle in the real estate sector. It will consolidate the buying sentiments with lower EMI. There is a slight reform in liquidity issues in the sector after two back to back rate reductions, and a cut-down for the straight third time will definitely undertake the liquidity shortfall in the sector at large. We expect more such actions by RBI on the liquidity front."

Manju Yagnik, Vice Chairperson of Nahar group: "As the monetary policy committee today announces a cut down on the interest rates by 25 basis points, this movement has set in motion the ever awaited change in the real estate sector. The following rate cut will certainly lead to reduction in interest rates charged by banks on home loans which will furthermore reduce EMI on housing. The stance change from neutral to accommodative by RBI will boost consumption and assist in regular cash flow in the market. This is a positive encouragement to all those seeking homes and brings a relief to us developers as well since after a dry spell, we see a potential rise in the real estate sector."

Here are some thought-provoking tweets: