The Reserve Bank of India (RBI) kept the key policy rate, or the repo rate, unchanged in the first bimonthly policy review of 2017-18 but narrowed the policy corridor by 25 bps by raising the reverse repo rate to 6%, from 5.75%.
All six members of the monetary policy committee (MPC) — which decides interest rates — voted in favour of the decision.
The central bank said the policy decision was consistent with the neutral policy stance with the objective of achieving the medium-term target for retail inflation, which is 4%.
“The MPC saw the path of inflation in 2017-18 challenged by upside risks and unfavourable base effects towards the second half of the year,” Urjit Patel, governor, RBI, said in the post policy press conference.
“Accordingly, inflation developments have to be closely monitored with food price pressures can be checked so that inflation expectations can be anchored,” he said.
The central bank said the future course of monetary policy would largely depend on incoming data on how macroeconomic conditions are evolving.
While the repo rate action was in line with market expectations, the governor’s hawkish tone disappointed bond traders who were expecting a softer tone. Yield on the 10-year benchmark bond hardened to 6.77% as compared with its previous close of 6.65%.
Inflation, a challenge
RBI said the path to achieving 4% inflation would be challenging. The central bank has set its inflation projection to an average of 4.5% in the first half of 2017-18 and 5% in the second half, while keeping its GVA growth projection unchanged at 7.4% for FY18 as compared with 6.7% in FY17.
“The move to the 4% target inflation will be challenging. There is no lucky dis-inflationary forces in the horizon that were there in the past,” RBI executive director in-charge of monetary policy, Micheal Patra said.
The central bank said while surplus liquidity in the banking system had fallen from close to ₹8 lakh crore in January to ₹4.8 lakh crore in March. The central bank said it had proposed a standing deposit facility to the government in November 2015, approval for which was still awaited. SDF is a mechanism to drain surplus cash at a rate lower than the repo rate without the need for any collateral.
“We are awaiting a decision on our preferred facility, which is the standing deposit facility. Beyond that, we may deploy other tools if our toolkit remains constrained and contingencies that arise so demand,” deputy governor Viral Acharya said.
Analysts said there were upside risks to the 4% target and there was a possibility of an increase in the cash reserve ratio, going forward.
“We expect higher rural wage growth, a narrowing output gap and adverse base effects to push inflation closer to 5.5-6.0% in H2 FY18,” Nomura said in a report to its clients. “As inflation risks become apparent, we also expect a 100 bps CRR hike in H2 2017 to absorb surplus liquidity,” it said.
Though RBI has not reduced the repo rate,banks still have scope to cut lending rates, the central bank said. It added that the small savings rates should also be lowered as it noted that these rates are 61-95 bps higher compared with the ‘what-if’ formula (which was introduced in April 2016 to calculate it).
