The Reserve Bank of India kept interest rates unchanged, citing pressure on prices, and bumped up inflation forecast for the rest of the fiscal year marginally, signalling that they may remain on hold next year too as there’s sufficient cushion before either shifting stance or embarking on a tightening cycle.
Inflationary pressures could build up from a variety of factors — a possible slide in the fiscal position, rising crude oil prices or disturbances in the global financial markets when the Federal Reserve unwinds easy liquidity, as credit growth begins to gain momentum in the domestic market.
The central bank also warned state-run banks that capital infusions recently announced by the government would be based strictly on merit — lenders won’t get money unless they clean up their act. RBI governor Urjit Patel said a principle of “reform and recapitalisation” would be followed to ensure that mistakes of the past are not repeated.
Reserve Bank Keeping Close Watch on Data
The regulator has also capped commissions on debit card transactions in line with the government’s agenda of pushing digital transactions.
RBI said the policy panel maintained a neutral stance, adding that a close watch will be kept on data over the next few months. The sixmember Monetary Policy Committee (MPC) voted five to one in favour of the status quo on interest rates. The repo rate, at which RBI lends to banks, remained at 6%. “
The MPC took note of the upside pressures of food and fuel prices on evolving cost of living conditions and inflation expectations,’’ governor Patel, who also heads the MPC, told reporters. “The committee expressed concern about the implications for the inflation outlook of possible fiscal slippage and global financial instability heightening asset price volatility.’’
A majority of the 20 participants in an ET poll had expected rates to remain unchanged. Many of them had also expected some tightening of the central bank’s stance from neutral, which didn’t happen. The panel has been mandated to keep consumer price inflation at 4% with a two percentage point band on either side. Inflation is estimated at 4.3-4.7% in the third and fourth quarters.
Market responses were mixed. The BSE Sensex ended 0.63% down at 32,597, while bonds rallied from their lows by five basis points to 7.03% after the RBI said it would return to neutral liquidity by the first half of next year. The rupee lost 0.2% to close 64.52 to the dollar.
Ravindra Dholakia continued to be the sole dissenter on the committee, voting yet again for a rate cut — of 25 basis points. The others — Patel, RBI deputy governor Viral Acharya and executive director Michael Patra, along with outside members Chetan Ghate and Pami Dua — voted to hold rates. A basis point is one-hundredth of a basis point. This is the fourth time in a row that Dholakia has cast a dissenting vote. When the MPC voted for a quarter point cut in August, Dholakia had sought a reduction of 50 basis points.
“Both growth and inflation are headed higher, but we expect rates to be on hold through 2018 as the RBI has a sufficient real rate cushion to absorb higher inflation,” said Sonal Varma, economist at Nomura Securities.
The central bank was optimistic about economic growth amid rising demand for credit and its surveys showing optimism that fresh orders are beginning to pile up.
“The MPC’s decision was also conditioned by recent developments that augur well for growth prospects,” said governor Patel. “In the primary capital market, resource mobilisation has increased significantly. It will add to demand in the short run and boost the growth potential of the economy over the medium term. Recent reforms have contributed to an improvement in India’s ease of doing business ranking which should help sustain foreign direct investment.’’
GROWTH PROJECTION UNCHANGED
The central bank kept its growth projection for the fiscal year — gross value added (GVA) at 6.7% — unchanged from the October policy announcement.
The finance ministry said the policy acknowledged that prices have been kept in check as well as the effectiveness of government reform measures.
“The MPC recognised that inflation remains firmly under control, retaining its inflation projection for the second half of FY 2018 and assessing that the risks to this projection are evenly balanced,” the ministry said in a release. “The MPC has also retained its annual GVA forecast for FY 2018 of 6.7% recognising several significant developments and emphasising the government’s reform efforts such as GST (goods and services tax), bank recapitalisation package and improving ease of doing business ranking.”
The MPC has been cautious in yielding to the demands of investors and industry for an interest rate reduction due to two of the key factors determining the cost of living conditions and inflation expectations — food and fuel prices—edging up.
“Inflation expectations of households surveyed by RBI have already firmed up and any increase in food and fuel prices may further harden these expectations,” RBI said. “Second, rising input cost conditions as reflected in various surveys point towards higher risk of pass-through to retail prices in the near term. Third, implementation of farm loan waivers by select states, partial rollback of excise duties and VAT in the case of petroleum products, and decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage.”
Another factor was global financial instability related to “monetary policy normalisation” and fiscal expansion in the US. Seasonal declines in fruit and vegetable prices and the effect of cuts in GST rates on a number of items last month could ease upside pressures. On the positive side are a pickup in credit growth over the past few months and the possibility that bank recapitalisation will boost this further. The Consumer Price Index hit a seven-month high in October, led largely by higher vegetable and fuel prices, rising 3.58% over the same month last year. The economy expanded 6.3% in the September quarter from a year earlier, up from the three-year low of 5.7% in the preceding one. The minutes of the December 5-6 MPC meeting will be published on December 20. The next meeting of the MPC is scheduled on February 6 and 7, 2018.