India’s central bank cuts interest rate to give growth a chance

• This is India's first rate cut in 18 months.
  
• Furthermore, the central bank changed its stance to “neutral”, indicating a possibility of another rate cut in the next few months.
  
• After retail inflation crashed to a 18-month low in December 2018, it was widely expected that the RBI would have enough leeway to cut rates this month.

The Reserve Bank of India (RBI) opted to cut interest rates by 25 basis points to 6.25%. Furthermore, the central bank, which is now headed by government insider Shaktikanta Das, changed its stance to “neutral”, indicating a possibility of another rate cut in the next few months.

Markets had already run up on Wednesday hoping for this slash in interest from the RBI. Benchmark indices, Sensex and Nifty, continued to hold on to the gains after the decision.

After retail inflation crashed to a 18-month low in December 2018, it was widely expected that the RBI would have enough leeway to cut rates this month after having to hike rates consecutively in June and August last year and maintaining a “calibrated tightening” stance in December.

However, the Modi administration’s expansionary budget put a question mark around those plans. A cash handout scheme for farmers, a pension scheme for informal sector workers and tax breaks for the middle class have raised the probability of fiscal slippage. The stimulus package was expected to have an inflationary effect, which is why many thought that the RBI would opt for a wait-and-see approach.

In June 2018, the central bank hiked rates for the first time in four years in response to higher inflation and a depreciating rupee - both of which were a outcome of rising fuel prices.

The last time the RBI opted for monetary tightening was in January 2014, when it increased the repo rate to 8% to keep inflation in check. It had since reduced interest rates to support economic growth amid a global decline in oil prices.



As fuel and food prices have moderated in recent months, the latter due to oversupply in the agricultural sector, inflation has been consistently trending downwards. Furthermore, having stalled at 3.6% for 2018-19 and 2019-2020, retail inflation is well below the RBI’s target of 4%, which had raised the prospects for a rate cut.


Excluding food and fuel, core inflation has hovered around the 6% owing to higher medical and education costs. The divergence across different inflation baskets has caused the RBI to opt for conservatism when it comes to interest rate decisions.

With the inflation outlook subdued, amid lower crude prices, the RBI likely felt the need to cut rates to spur economic growth. More importantly, ahead of national elections in May, a reduction in the cost of home loans and short-term loans for working capital is expected to lead to higher consumer and business confidence.


SEE ALSO:


Markets just can't believe India's latest budget math


Here’s why the Reserve Bank of India hiked interest rates for the first time since January 2014