The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) yesterday announced a repo rate cut of 25 bps from 6.50% to 6.25%. For people who don't know what repo rate is, it is the benchmark interest rate at which the RBI lends money to banks. It is the key metric based upon which banks calibrate their rates at which to give loans to consumers and corporates. RBI's rate cut decision came as a surprise to many as they had believed that the central bank might look at the elevated levels of core inflation and the risks associated with the potential increase in fiscal deficit from several proposals in this year's union budget.
Even analysts who believed that the rate cut from RBI was a consequence of benign inflation rate levels, failed to understand that RBI mainly looked at the prevailing global headwinds as a risk to growth in India. According to RBI's Monetary Policy statement yesterday, it highlighted the key risk to India GDP growth numbers to the slowdown in global economic activity. The statement mentioned, "Among key advanced economies (AEs), economic activity in the US lost some steam in Q4:2018. The outlook for Q1:2019 is clouded by the partial government shutdown, though the labor market conditions remain strong. In the Euro area, economic activity lost momentum on weak industrial activity. The Japanese economy is gradually recovering and an accommodative monetary policy stance is expected to buttress domestic spending."
RBI also highlighted the key risks associated with the slowdown in emerging markets as well. China's growth decelerated in the last quarter. Russian economy suffered from a slowdown due to the soft crude oil prices. Brazilian and South African economy is also experiencing weak industrial activity.
In particular, RBI mentioned the US-China trade relations to be a key risk factor to global growth. Talking about domestic growth, RBI mentioned that the actual growth of 7.2% for 2018-19 came out to be lower than its expectations of 7.4%. It now expects 2019-20 growth to come at 7.2%-7.4% down from 7.5% that it expected earlier. This clearly shows that RBI expects risk to India's GDP growth numbers, which is why it made the right decision in cutting interest rates. The Nifty 50 index yesterday closed almost flat as the good news of the reduction in interest rates nullified the lower than expected GDP growth outlook.
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