RBI Keeps Rate Steady Flags Reluctance for Cuts in Near Future

  • 09-Feb-2017
  • RBI Keeps Rate Steady Flags Reluctance for Cuts in Near Future

MUMBAI: The Reserve Bank of India (RBI) kept the repo rate—its key lending rate—unchanged at 6.25 percent on Wednesday, flagged concerns about rising commodity prices and cut India’s growth forecast to 6.9 percent in 2016-17 while conceding demonetisation’s “transient” impact on spending and investment.

The six member monetary policy committee (MPC), headed by RBI Governor Shri Urjit Patel, chose to ignore calls from business leaders for cheaper loans to aid investment and household spending.

The panel wanted low inflation to persist longer before the central bank cuts rates. Patel told a news conference that the committee had decided to change its stance to “neutral,” from “accommodative” meaning a lower chance of rate cut in the near future given growing inflation risks.

The decision to keep rates constant means that households may have to wait longer for cheaper bank loans to buy houses and goods such as cars, although Patel said that the full “transmission” of previous central bank rate cuts haven’t happened, implying that banks haven’t fully passed on the benefits of lower rates to consumers yet.

As opposed to 175 basis point (1.75 percentage point) rate cut in the repo rate over the past two years, the average bank lending rates have come down by 85-95 basis points (0.85 to 0.95 percentage points), Patel said, suggesting that banks enjoyed enough elbow room for cheaper consumer borrowing rates. Data released last month showed that India’s retail inflation rate grew 3.41 percent in December from November’s 3.63 percent, confirming fears of weak demand as households, hit by a demonetisation-induced cash crunch, put off spending.

The RBI and the Government have set a retail inflation target of 4 per cent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 per cent. Patel said the committee (MPC) remains committed to bringing headline inflation closer to 4 percent “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,” the RBI monetary policy statement said. Inflation expectations—or the view among consumers and businesses of where prices are heading—are high, which implies that households expect the cost of living to remain high partly because of costlier services.

“Within the rising profile of international commodity prices, crude oil prices firmed up with the OPEC’s agreement to curtail production. Prices of base metals have also increased on expectations of fiscal stimulus in the US, strong infrastructure spending in China, and supply reductions. Geopolitical concerns have also harden, the appetite for risk has returned in advanced economies, buoying equity markets and hardening bond yields as a response to the growing likelihood of further increases in the Federal Funds rate during the year. Coupled with expectations of fiscal expansion in the US, this has propelled the US dollar to a multi-year high, which can fan inflation in India by knocking up prices of imported goods.

Investment activity also remain muted, although the RBI was bullish about quick revival, shrugging off the adverse effects of the currency drain out. The 76th round of the Reserve Bank’s industrial outlook survey suggests that financing conditions facing the manufacturing sector have worsened in October-December of 2016-17 and are expected to remain tight in January-April. This is corroborated by the sharp slowdown in bank credit to industry and continuing sluggishness in the investment climate in some sectors. It projected the Indian economy’s gross value added (GVA)—a proxy to measure GDP—to growth at 6.9 percent in 2016-17, lower than the Central Statistics Office’s advanced estimates of 7.1 percent.

The RBI expects growth to recover sharply to 7.4 percent in 2017-18 on account of several factors.

First, discretionary consumer demand held back by demonetisation is expected to bounce back beginning in the closing months of 2016-17.

Second, economic activity in cash-intensive sectors such as retail trade, hotels and restaurants, and transportation, as well as in the unorganised sector, is expected to be rapidly restored.

Third, demonetisation-induced ease in bank funding conditions has led to a sharp improvement in transmission of past policy rate reductions into marginal cost-based lending rates (MCLRs), and in turn, to lending rates for healthy borrowers, which should spur a pick-up in both consumption and investment demand.

Source: Dailyshippingtimes.com

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