RBI's monetary policy committee leaves repo rate unchanged at 6.25%
Published: Feb 09, 2017
By TIOLCORP News Service
MUMBAI, FEB 09, 2017: THE Reserve Bank of India (RBI) on Wednesday signalled an unexpected early end to the two-year-old rate cut cycle, citing concerns of resurgent inflation, and left its key policy rate unchanged. RBI's monetary policy committee (MPC), headed by governor Urjit Patel, decided unanimously to shift the policy stance from "accommodative" to "neutral" and left the repo rate at 6.25%.
The shift in stance means the central bank is unlikely to cut rates anytime soon, let alone in April, when the MPC will next review policy. RBI hit the pause button after cutting the repo rate, at which it infuses liquidity into the banking system, by 175 basis points (bps) since the start of 2015—150 bps of it under previous governor Raghuram Rajan before his tenure ended in September 2016. One basis point is one-hundredth of a percentage point. The MPC said it was still assessing the transitory effects of demonetisation on inflation, and the output gap. It also cited significant upside risks to inflation, such as rising crude prices and exchange rate volatility. Output gap is the gap between actual economic growth and potential economic growth.
"The committee remains committed to bringing headline inflation closer to 4.0% on a durable basis and in a calibrated manner. This requires further significant decline in inflation expectations, especially since the services component of inflation that is sensitive to wage movements has been sticky," said RBI's monetary policy statement. Bond prices fell after the shift in policy. The yield on the 10-year benchmark bond rose to close at 6.739% from Tuesday's 6.431%. Bond prices and yields move in opposite directions.
Retail inflation decelerated to a two-year low of 3.41% in December, but RBI seems more focused on non-food, non-fuel inflation. Governor Patel said that had vegetable prices been excluded, inflation in December would have been 1.4 percentage points higher.
Rising commodity prices, strengthening of the dollar, and the effects of the house rent allowance increase in the Seventh Pay Commission award were the other reasons which made the central bank pause. RBI is aiming to keep retail inflation under 5% in the fourth quarter and at 4% within a band of 2 percentage points on either side in the medium term.
At the same time, the central bank is expecting a bounceback in growth in the coming financial year, even though its gross value added projections show only a 50 basis-point bump-up to 7.4% in 2017-18. RBI said that growth will accelerate as discretionary consumer demand, held back by demonetisation, picks up, cash-intensive sectors such as retail trade and hospitality rebound, and consumption and investment demand recover.
For consumers, any fall in lending rates will now come from banks transmitting more of the 175 bps of policy rate cuts since early 2015. Patel said only about 85-90 bps of this has been passed on to consumers, referring to the so-called weighted average lending rate. Wednesday's policy statement added that a quick resolution of the bad loans problem at Indian banks and speedy recapitalization would aid rate transmission. Since the demonetisation drive ended on 30 December, most large banks have cut their marginal cost of funds-based lending rates (MCLR), with the State Bank of India reducing rates by up to 90 bps. The bank rate cuts were supported by a large inflow of low-cost deposits after the government invalidated Rs500 and Rs1,000 currency notes.
Some experts have said that the decision to keep the policy rate unchanged and the change in stance to neutral is based on a judicious assessment of risks.
