RBI kept the Repo Rate unchanged despite revising the policy stance from Neutral to Calibrated Tightening. The status quo in the Repo Rate was against market expectations and the INR bore the brunt of the policy by falling to below Rs 74 to the USD for the first time on record.
The RBI policy action goes against the current market environment where rate hikes were warranted, largely for the RBI to catch up with the curve as government bond yields are trading over 8% levels, over 150 bps above the Repo Rate of 6.5%. Sharply falling INR, global risk aversion with EM currencies and equities falling sharply, rise in US treasury yields, uncertainty over oil prices and the sharp fall in Indian equities, all suggests that a rate hike was prudent especially as the market was expecting a rate hike.
The reason that the RBI did not hike rates this policy is the current ongoing mess in credit markets caused by IL&FS default. RBI did not want to frighten markets with an immediate hike, which could potentially freeze credit markets, as there is huge credit risk aversion to NBFCs among lenders. However, a mere hold on rates will not unfreeze the markets and more concerted actions are required. Read our note on Government and RBI measures required to tackle IL&FS mess.
RBI highlighted the fall in food price inflation for its downward revision in inflation projections. However, all other indicators from rise in oil prices (despite a cut in excise duty), falling INR, capital outflows, pass through of higher input prices to the end user and potential weakening of central government and state finances, all point to a rise in core inflation that is hovering at 6% levels.
The markets are not going to be enthused by the lack of a rate hike and would largely look at RBI liquidity measures, tackling of the IL&FS mess, second quarter FY 19 corporate results and global cues for direction.