If economic activity is at a 2-year low, why isn’t RBI more dovish

A double whammy of muted consumption demand and delayed capex revival is weighing on economic growth. (Vipul Sharma/Mint)

Mumbai: While the Reserve Bank of India’s (RBI’s) decision to cut the repo rate by 25 basis points on Thursday was widely expected, some market participants are wondering why it didn’t change its monetary policy stance as well, especially when economic activity has moderated considerably in recent months.

A double whammy of muted consumption demand and delayed capital expenditure revival is weighing on economic growth.

An Economic Activity Index compiled by brokerage house Jefferies India Pvt. Ltd has slipped below 3% in February, the lowest in two years. The index consists of a number of indicators, such as passenger and commercial vehicle sales, electricity demand, cement production, exports, railway freight, and credit growth.

“Most indicators saw muted growth trends in February. Consumption, trade and capex data were the key negative. Momentum indicator also remained negative with 14 of the 36 indicators deteriorating,” Jefferies India said in a report on 3 April.

Given a weak domestic economy and the dovish stance of global central banks, RBI was expected to follow suit. But it maintained a neutral stance.

“The policy guidance was not as dovish as markets expected. That the stance was maintained at ‘neutral’ underscores our expectations that the committee prefers to stay data-dependent, but with a dovish bias,” DBS Bank Ltd said in note.

Arvind Chari, head of fixed income at asset management firm Quantum Advisors Pvt. Ltd, said: “The MPC (monetary policy committee) has not only retained the stance at neutral, they rightfully seem cautious about oil prices and are more sanguine about growth prospects than what the current drop in activity suggests.”

As it turns out, the central bank has projected gross domestic product growth of 7.2% for FY20, much higher than the forecast of 6.8% by Fitch Ratings. While it did mention a slowdown in economic activity in its policy statement, RBI balanced it out by saying that there were upside risks as well.

A slew of economists are estimating another 25 basis point rate cut in June. But given the risks to inflation from rising crude oil prices and fears of a below-par monsoon, the central bank may not change its stance in a hurry.