In an unexpected announcement, India’s central bank left borrowing costs unchanged for a second straight meeting, shifting its policy stance to neutral from accommodative, effectively signaling an end to easing cycle. The RBI left the benchmark repurchase rate at a six-year low of 6.25 percent, on expectations of a 25 bps cut. Central bank authorities left rates unchanged at the last, December 7 meeting, while saying that the policy stance remains accommodative.
“The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetization on inflation and the output gap play out,” the RBI said. Governor Urjit Patel said the shift to neutral gives the central bank policy flexibility. “The non-food part of the consumer price index has been sticky at 4.8 to 4.9 percent,” Patel said at a press conference, adding that had it not been for a destruction of vegetables and other perishables due to the cash ban, consumer price inflation would have been 140 basis points higher than the 3.4 percent seen in December.
According to Bloomberg, the unchanged move was predicted by just five of 39 economists in its in house survey, while the rest saw a cut to 6 percent. The central bank forecast a sharp recovery in growth during the year through March 2018, helped by a rebound in consumption that has been hurt by Prime Minister Narendra Modi’s unprecedented cash ban.
Sovereign bonds plunged as several analysts were counting on lower borrowing costs to revive an economy hit by Modi’s withdrawal of some high-denomination currency notes last year. The Nifty 50 index dropped 0.5 percent to 8,723 while the Sensex fell over 160 points to 28,173. The Nifty Bank Index extended decline to over 1 percent post the RBI's policy status quo. All 12 members of the index declined. The yield on government notes due Sept. 2026 surged 26 basis points to 6.69 percent as of 4:05 p.m. in Mumbai, according to prices from the RBI’s trading system.
Key points from the statement courtesy of Bloomberg:
- Six members voted in favor of the monetary policy decision
- Inflation is projected in the range of 4 percent to 4.5 percent in the first half of the financial year starting April 1 and in the range of 4.5 percent to 5 percent in the second half with risks evenly balanced around this projected path
- Growth in gross value added -- a key input for gross domestic product -- for 2016-17 is projected at 6.9 percent with risks evenly balanced around it. GVA growth for 2017-18 is projected at 7.4 percent, with risks evenly balanced
India joins Russia’s central bank, which this month also held rates as the prospect of more tightening from the U.S. Federal Reserve limits space for global peers to ease.
“The RBI has become very hawkish at a time when the country faces an acute slowdown caused by the cash ban,” said Rupa Rege Nitsure, group chief economist at L&T Finance Holdings Ltd. in Mumbai. “Even inflation readings have been benign. So it’s disappointing, their change in stance to neutral.”
The RBI’s decision risks frustrating Modi, who faces five state elections over February and March. Growth in gross domestic product may slow to 6.5 percent in the year through March from 7.9 percent the previous year as the cash clampdown hurts demand. The government’s pledge to keep narrowing Asia’s widest budget deficit had spurred hopes for monetary easing as had inflation, which is below the 4 percent midpoint of the RBI’s target range.
However, a surge in deposits following the cash ban offers commercial lenders room to lower their rates, Governor Patel said. Economists including Sonal Varma at Nomura Holdings Inc. predict a sharp economic recovery June-December as cash in the system increases.
A surprised sellside responded to the move as follows:
Nomura Holdings (Vivek Rajpal, rates strategist)
- Don’t think market was positioned for change in stance to neutral
- Bonds will trade in higher range, probably 6.45% to 6.75% will be new range 10-year yield
Standard Chartered (Nagaraj Kulkarni, senior rates strategist)
- Price action suggests rates market is unwinding all of its rate-cut expectations
- Expect “bear steepening of the rates curve” to persist in near term
- Says shift in RBI’s stance and resulting change in Standard Chartered’s policy rate view has implications for its yield forecasts, which now under review
Dai-ichi Life (Toru Nishihama, EM economist)
- Decision to keep policy rate unchanged is quite a “big surprise,” and bond yields are jumping because market had priced in a rate cut
- Inflation remains low and that would mean room for a future rate cut probably still remains
Credit Suisse (Deepali Bhargava, economist)
- “Bottom-line is that we are at the bottom of the cycle”
- RBI may still cut once more if inflation remains below 4% till March
Macquarie (Nizam Idris, head of FX and FI strategy)
- RBI seems to think that there’s sufficient liquidity and sufficient easing which may be better transmitted now after demonetization
- Central bank showing preference to be on cautious side side rather than supporting growth
- INR may take guidance from stocks in short term
Capital Economics (Shilan Shah, economist)
- While the economy has taken a hit from demonitization, it hasn’t been catastrophic
- Continue to think that rate hikes will come onto the agenda much sooner than is generally anticipated
- RBI may begin hiking rates over next 12-18 months as its medium-term inflation target comes under pressure