India’s central bank chooses to keep interest rates on hold, unveils a new pricing policy for retail and small business loans

(Image source- Reuters)

  • At its bi-monthly meeting yesterday, the central bank’s Monetary Policy Committee decided to keep interest rates unchanged at 6.5% for the second time in a row.
  • The move, which was widely in line with market expectations, was largely due to a strong growth outlook in the ensuing quarters amid a moderation in inflation and oil prices and a halt in the rupee’s decline.
  • The RBI also moved to make the pricing of loans with floating rates to retail customers and micro, small and medium-sized enterprises (MSME) more transparent by aligning them with an external benchmark.
In the first meeting of the central bank’s Monetary Policy Committee since the very public rift between the Reserve Bank of India (RBI) and the Modi government, the committee decided to keep interest rates unchanged at 6.5% for the second time in a row.

The move, which was widely in line with market expectations, was largely due to a strong growth outlook in the ensuing quarters amid a moderation in inflation and oil prices and a halt in the rupee’s decline. In fact, the RBI cut its inflation forecast for the second half of 2018-19 to 2.7%-3.2% from 3.9%-4.5%. It also pegged inflation in the first half of 2019-2020 at 3.8-4.2% from an earlier range of 3.8-4.5%.

The six-member committee also opted to maintain the stance at “calibrated tightening”, indicating the possibility of inflationary pressures in the near future given the obvious volatility in crude oil and foreign currency markets. However, if this doesn’t pan out and inflation continues to moderate, the RBI could very well cut rates or move to a “neutral” stance. It has so far raised rates twice, by 0.25 percentage points each, in the financial year so far.

This is a remarkable turnaround from the last meeting in October, when the RBI changed its stance from “neutral” to “calibrated tightening”. However, this was at the height of the rupee’s freefall and a surge in capital outflows and oil prices, which was trading more than $20 higher at $85/barrel.

The decision indicates the lower probability of rate hikes in the near term, which is bound to boost investor sentiments and provide a fillip to growth amid a possible liquidity crisis in the non-banking financial sector. As domestic inflation falls short of forecasts, the government will do what it can to prevent a continued reduction in food prices as this will hurt farmer incomes. That could invariably lead to more announcements of minimum support prices for certain agricultural commodities.

Transparent pricing of loans

The RBI also made a number of important additional announcements. It has moved to make the pricing of loans with floating rates to retail customers and micro, small and medium-sized enterprises (MSME) more transparent by aligning them with an external benchmark, in this case - the repo rate or rate of interest on treasury bills.

The move, which is effective from 1 April 2019, will limit the deviation over the benchmark rate. Banks currently have a freer hand when it comes to setting rates on these loans, but will not be able to now have to maintain the same spread over the benchmark throughout the life of the loan unless a borrower’s credit rating changes significantly. All banks will also be required to maintain the same external benchmark for a specific loan category. The move is largely a response to banks’ aversion to passing on rate cuts from the central bank to their customers.

Separately, the RBI also decided to appoint a committee of experts to oversee and devise solutions for the stress in the MSME sector. The lack of access to working capital loans for small businesses was a huge sticking point between the central government and the RBI, which eventually decided to formulate a restructuring scheme for SME bad loans and allow shadow banks to sell their loans off with greater ease. The composition of members for the expert committee are expected to be finalised by the end of 2018 with a final report due by June 2019.


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