Surprising the markets, the Reserve Bank of India (RBI), on Wednesday, kept the indicative policy rates (repo) and cash reserve ratio (CRR) unchanged. However, it said that it would act if inflation rates remain at stubbornly high levels.
The RBI kept the repo rate at 7.75 per cent, and kept the CRR, which is the portion of the total deposits the banks have to keep with the central bank as a reserve, at the current level of 4 per cent. Repo rate is the short term rate at which banks borrow funds from the central bank.
“Even though the Reserve Bank maintains status quo today…if the expected softening of food inflation does not materialise…or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold,” said Raghuram Rajan, Governor, RBI while announcing the third mid-quarter review of its monetary policy here.
“The Reserve Bank’s policy action on those dates will be appropriately calibrated,” he added.
Justifying his action of not hiking the rates, Dr. Rajan said “given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty.”
“When the RBI cut rates, the cuts were not transmitted. So, there is a certain lag in the system,” said Dr. Rajan. Going forward, he said, “We will have to calibrate the policy to the circumstances. Our sense is that growth in the second half will be stronger than in the first half. Of course, factors like agriculture, exports and the long awaited aspect of stalled projects coming back will help growth and sentiments.”
RBI Governor said that retail inflation measured by the consumer price index (CPI) has risen unrelentingly through the year so far, “pushed up by the unseasonal upturn in vegetable prices, double-digit housing inflation and elevated levels of inflation in the non-food and non-fuel categories.”
Wholesale inflation has also gone up sharply from second quarter onwards, with upside pressures evident across all constituent components. “High inflation at both wholesale and retail levels risks entrenching inflation expectations at unacceptably elevated levels, posing a threat to growth and financial stability.”
“There are also signs of a resumption of high rural wage growth, suggesting second round effects that cannot be ignored. High and persistent inflation also increases the risks of exchange rate instability,” Dr. Rajan added.
However he said there are indications that vegetable prices may be turning down sharply, although trading mark-ups could impede the full pass-through into retail inflation. In addition, the disinflationary impact of recent exchange rate stability should play out into prices. Finally, the negative output gap, including the recent observed slowdown in services growth, as well as the lagged effects of effective monetary tightening since July, “should help contain inflation.”
The pick-up in real GDP growth in the second quarter of the current fiscal was driven largely by robust growth of agricultural activity, supported by an improvement in net exports, said Dr. Rajan, adding, the weakness in industrial activity, however, persisting into the third quarter, still lacklustre lead indicators of services and subdued domestic consumption demand suggest continuing headwinds to growth.
