RBI cites looming inflation, holds the repo

India Inc and the government will have to wait longer for an interest rate cut as the Reserve Bank, citing worries on the inflation front, stood chose to hold key lending rates.

The RBI’s six-member monetary policy committee (MPC) decided by a majority vote of 5 to 1 to keep the repo rate (the interest rate at which banks borrow funds from the central bank to overcome short-term liquidity mismatches) unchanged at 6 per cent and also decided to keep the policy stance neutral.

This rate was last cut — from 6.25 per cent — in the August policy review. Market players expect the RBI to pare the repo rate only its review of February 2018.

Even as it marked down gross value added (GVA) growth projection for FY18 from 7.3 per cent to 6.7 per cent, the central bank cautioned that farm loan waivers and fiscal stimulus could undercut macroeconomic stability.

Given that the RBI has not cut the repo rate, banks are unlikely to tinker with their deposit and lending rates. In the last year or so, ample liquidity has pushed banks to cut rates.

The Reserve Bank said the inflation path for the rest of the current fiscal is expected to be shaped by several factors, including possible lower kharif (summer) crop production, some price revisions due to implementation of the GST (goods and services tax), broad-based increase in CPI-based inflation, excluding food and fuel, and firming global crude prices.

Thus, inflation is expected to rise from its current level and range between 4.2-4.6 per cent in the second half of this year, also factoring in the house rent allowance by the Centre.

“We will be watching incoming data carefully and there are upside risks (to inflation), which we have enunciated, there are some things which may mitigate these risks. So, we will basically have to wait and watch on how the evolution of inflation takes place over the next six-seven months…inflation has been volatile, within two months it did increase by 2 percentage points, so we will see what happens,” said Urjit Patel, Governor.

He added that the MPC remains committed to keeping the retail inflation closer to 4 per cent on a durable basis.

The RBI cautioned that the factors that continue to impart upside risks to the inflation trajectory include implementation of farm loan waivers by States, which may result in possible fiscal slippages; and implementation of the 7th Pay Commission recommendations by the States’ similar to that by the Centre could push up headline inflation by about one percentage point above the baseline over 18-24 months, a statistical effect that could have potential second round effects.

“The MPC expressed concern about the loss of momentum of growth in the early months of FY18, especially the persisting weakness in manufacturing. The MPC noted that the implementation of GST appears to have rendered short-term prospects uncertain, possibly delaying the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporations,” said Patel.