Why The RBI's Decision to Not Cut Rates in December has Shocked Many

The central bank has a critical role to play in a country’s economic growth. Even though functionally independent, central banks have to take into account the government’s needs while deciding policy rates, a key tool of monetary policy. To increase transparency and accountability, and improve coordination between the government and the central bank, India moved to a committee-based approach for monetary policy. Under the current system, a six-member monetary policy committee (MPC) of the Reserve Bank of India meets every two months to deliberate on interest rates. In the latest meeting, the committee unanimously voted to keep the repo rate—the rate at which banks borrow from the RBI—unchanged at 5.15%.

The rationale for the pause

A repo rate is a critical tool of monetary policy and the RBI uses it to control the money supply in the economy. Oversupply of money can lead to inflation, while a scarcity can affect growth. The monetary policy in India is primarily targeted at managing inflation and the MPCs surprising move to leave the repo rate unchanged can be attributed to inflationary pressure. Under the monetary policy framework, India had adopted an inflation target of 4% till March 31, 2021, with a lower tolerance level of 2% and an upper limit of 6%. The inflation rate hovered near the 4% target in the first half of the year but has started inching up primarily due to rising prices of onion, pulses, sugar and milk. The consumer price inflation rose to 4.62% in October, surpassing the 4% level for the first time since July 2018. The central bank has also revised its inflation target for the second half of 2019-20 to 4.7%-5.1% from 3.5%-3.7% earlier. The prospects of inflation rate nearing the upper tolerance levels prompted RBI to leave the repo rate unchanged.

Source: The Economic Times

Another factor that probably led to RBI leaving the repo rate untouched is the problem with the transmission of rate cuts. In 2019, the RBI reduced policy rates cumulatively by about 135 basis points to 5.15%, the lowest level in nine years. Consumers, however, gained little as new loans have seen the transmission of just 44 basis points. The MPC decided to hold on the policy rate until the entire benefit of rate cuts gets reflected in consumer lending rates. Multiple cuts in repo rate have already made loans significantly cheaper in the country. Opt for a personal loan when you need funds for essential activities such as education, wedding or medical care. You can get Bajaj Finserv Personal Loan, available on Bajaj Markets, approved within three minutes. The Bajaj Finserv Personal Loan provides adequate flexibility in repayment with tenures ranging between 12 to 60 months.

The Surprise

The RBI had its reasons for leaving the repo rate unchanged, but the decision was shocking for many. One may ask what is so surprising in the central bank deciding not to lower the repo rate when inflation is inching up. Market participants and economists were expecting a 25 basis point cut and they were not completely wrong. Along with keeping inflation under control, the RBI is also partially responsible for boosting economic growth. A tight monetary policy due to excessive fixation with inflation can affect economic growth. The move is surprising as the RBI itself revised the GDP growth forecast for 2019-20 to 5% from an earlier projection of 6.1% after growth in the September quarter fell to a six-year low of 4.5%. Even after grim forecasts for the economy ahead, the central bank decided to press the pause button on rate cuts.

The move is also baffling as some experts opined that monetary policy works with a lag of 2-3 quarters in India, which means a rate cut in December will show its effect by the September quarter of the next year. Even though retail inflation is expected to move upwards in the next three months, as per RBI’s own projection it will gradually come below the 4% mark in the second half of 2020-21. If the inflation is expected to come down to desirable levels in three quarters, the RBI’s move to leave policy rates unchanged is indeed surprising.

Conclusion

The central bank may have left the interest rate unchanged, but the pause may not last long. Experts expect the RBI to resume rate cuts in 2020 as it gets more clarity on growth and inflation trajectories. Rate cut or not, you can avail a personal loan at attractive rates in the prevailing low-interest environment. Opt for Bajaj Finserv Personal Loan, available on Bajaj Markets, and enjoy flexible tenure and prompt disbursal. You can apply for personal loans to finance your education or wedding, or even to fund your travels.