Indian central bank slashes rates, warns of contraction

Mumbai: India´s central bank slashed interest rates on Friday in an effort to contain the economic fallout of the world´s largest coronavirus lockdown and warned the economy could contract this year.

Even before almost all activity shut down in late March, Asia´s third-largest economy was struggling to gain traction with sluggish growth, record unemployment and banks reluctant to lend.

The Reserve Bank of India (RBI) slashed the repo rate, the rate at which it lends to commercial banks, by 40 basis points to 4.0 percent, the second cut this year. The central bank also extended a moratorium on loans to a total of six months after its governor Shaktikanta Das said the economy was expected to contract in the 2020/21 fiscal year.

"The impact of coronavirus is turning out to be more than expected. GDP growth is estimated to remain in negative territory in 2021," Das told an online news conference.

"RBI will continue to be vigilant and will take whatever measures are needed to be taken due to covid pandemic," Das added. The RBI also lowered the reverse repo rate, the rate at which it borrows from commercial banks, by 40 basis points.

The bank had cut the repo rate by 75 basis points in March as fears grew over the spread of the virus in the country of 1.3 billion people.

Das said the Monetary Policy Committee (MPC) had voted to maintain its “accommodative” stance and members voted 5-1 on the quantum of the rate reduction. The RBI has cut the repo rate by a total of 115 bps since the lockdown began in late March.

“The MPC voted unanimously for a reduction in policy repo rate and for maintaining the accommodative stance of monetary policy as long as it is necessary to revive growth and to mitigate the impact of COVID-19 while ensuring that inflation remains within the target,” Das said.

India’s benchmark 10-year bond yield dropped as much as 18 bps to 5.85 percent immediately after the rate cut. “The off-cycle cut highlights the acute growth concerns that the RBI governor mentioned in his speech. The nimbleness of the RBI and its willingness to keep all options on the table is welcome,” said Abheek Barua, chief economist at HDFC Bank.

India’s lockdown, introduced on March 25 and extended until the end of May, has brought most economic activity to a standstill. “The combined impact of demand compression and supply disruptions will depress economic activity in the first half of the year,” Das said.

“Given all the uncertainties, GDP growth in 2021 is expected to remain in the negative territory with some pick-up in growth impulses being seen in H2 2021 onwards,” he added. Das also highlighted rising food price pressures from supply disruptions but said the MPC expects inflation to eventually fall below its medium-term target of 4 percent later in the year.

“It is in the growth outlook that the MPC judged the risks to be gravest,” Das said. “If the inflation trajectory evolves as expected, more space will open up to address the risks to growth,” he added.

Recent data have also set alarm bells ringing. Last month the purchasing managers index (PMI) of activity in the services sector suffered its sharpest contraction since it began in 2005, while inflation soared to 8.6 percent.

Das said the global economy was headed towards a recession because of coronavirus-induced disruptions to supply chains. India witnessed its steepest decline in trade in April, he added, with exports and imports both slumping around 60 percent.