RBI keeps lending rate at 6.25%

Governor says the bank had to absorb a surge in liquidity after demonetisation

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The Reserve Bank left its benchmark lending rate unchanged at 6.25 per cent today for the third policy review in a row citing upside risk to inflation. It however increased the reverse repo rate at which it pays to lenders by 0.25 per cent to 6 per cent, narrowing the policy rate corridor.

Given the upside risks to inflation and excess liquidity in the system, the repo rate has been retained at 6.25 per cent but the reverse repo has been revised upwards. The Marginal Standing Facility has been revised downwards (rpt) downwards by 0.25 per cent to 6.5 per cent, the central bank said in the first bi-monthly monetary policy review of 2017-18.

The central bank said the policy decisions are unanimous.  On the basis of gross value add, RBI sees the economy accelerating to 7.4 per cent in the current fiscal, up from 6.7 per cent in 2016-17.

However, the monetary authority said it is worried on three fronts on the inflation and the general economy. The first stems from a possible el nino impact on the monsoon. The second worry arises from the GST implementation and the third upside risks to inflation comes from the seventh pay commission award, according to the Monetary Policy Committee.

“For 2017-18, inflation is projected to average 4.5 per cent in the first half and 5 per cent in the second half,” the RBI said.  “The main one stems from the uncertainty surrounding the outcome of the south west monsoon in view of the rising probability of an El Nino event around July-August, and its implications for food inflation,” it said.

RBI Governor Urjit Patel said the bank had to absorb a surge in liquidity in the system after demonetisation, and the focused is on removing the liquidity overhang.

All 60 economists polled by the news agency Reuters had predicted the RBI’s monetary policy committee would keep the repo rate at 6.25 percent, where it’s been since October. The meeting was the first of four so far with panel-made decisions where forecasters correctly predicted the outcome.

The MPC’s vote was again 6-0, just like the previous meetings, as the panel continues to exhibit a united front in pursuing its objective of keeping inflation at around 4 percent, with elbow room of 2 percentage points at either side.

The RBI, which unexpectedly changed its policy stance to “neutral” from “accommodative” at its last review in February, reasserted its concerns about inflation. This comes in spite of calls for the RBI to do more to aid an economy growing at less than the 8 percent needed to create full employment.

“The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth,” said the RBI in the statement.

India’s benchmark 10-year bond yield rose 6 basis points to 6.75 percent after the decision, but the rupee was range-bound at around 64.94 per dollar after earlier strengthening to as much as 64.8825.

The Nifty was down 0.2 percent for day, after strengthening slightly following the RBI statements. The consumer inflation rate climbed to 3.65 percent in February from a year earlier, picking up from its lowest levels in at least five years to approach the RBI’s target of 4 percent.

The RBI is concerned that food prices could spike should India experience a below-average monsoon season in the middle of the year. It is also monitoring core inflation, which has stubbornly stayed around 5 percent for several months.

The state of the global economy is also weighing heavily within the RBI, as the U.S. Federal Reserve’s tightening gives additional pause to central banks around Asia, with Australia this week becoming the latest one to hold rates.

India seems in good stead after attracting $8.85 billion in investment into debt and equities in March – the most since at least 2002 – sending the Nifty to a record high and the rupee to a nearly 1-1/2 year high.

But the RBI has long worried about sudden reversals of foreign flows, after first-hand experience in 2013 when worries about Fed tightening plunged India into its worst currency crisis in more than two decades.