RBI policy: Rate unchanged; central bank sees upside risks to inflation due to El Nino

The Reserve Bank of India (RBI) on Thursday kept the interest rates unchanged but introduced new liquidity tools to manage the cash in the system saying the move “is consistent with a neutral stance of monetary policy”. [caption id=“attachment_3371116” align=“alignleft” width=“380”]  Reuters[/caption] The rate setting Monetary Policy Committee said in a statement that it expected the headline CPI inflation to undershoot the target of 5 percent for January-March of 2016-17. It also sees upside risks to baseline projection due to various factors. The target for gross value added for 2017-18 is 7.4 percent as against 6.7 percent in 2016-17. The move is largely in keeping with the expectation, as a Reuters poll of 60 economists had found all of them projecting a status quo on rates. There were also expectations that the central bank is likely to take measures to manage the funds in the banking system, which have gone up after the demonetisation of Rs 500 and Rs 1,000 notes. In February, India’s central bank was expected to cut rates but surprised markets by leaving them on hold and changed its stance to neutral from accommodative, ending its longest easing cycle since the global financial crisis. The repo rate - the key policy rate of the RBI - at present stands at 6.25 percent. The central bank, however, revised upward the reverse repo rate to 6 percent from 5.75 percent. The marginal standing facility rate has been 6.5 percent. The Bank Rate has also been revised down word to 6.5 percent. Listing the factors that are likely to impact the inflation going forward, the RBI pointed to the increasing possibility of El Nino. “The main one stems from the uncertainty surrounding the outcome of the south west monsoon in view of the rising probability of an El Niño event around July-August, and its implications for food inflation,” it said. Another risk is emanates from managing the implementation of the allowances recommended by the 7th Central Pay Commission (CPC). “In case the increase in house rent allowance as recommended by the 7th CPC is awarded, it will push up the baseline trajectory by an estimated 100-150 basis points over a period of 12-18 months, with this initial statistical impact on the CPI followed up by second order effects,” the statement said. The third risk is from the implementation of Goods and Services Tax. Meanwhile, the GVA acceleration to 7.4% is exprected to be supported by several domestic factors. “First, the pace of remonetisation will continue to trigger a rebound in discretionary consumer spending. Activity in cash-intensive retail trade, hotels and restaurants, transportation and unorganised segments has largely been restored,” the MPC said in the statement. Secondly, significant improvement in transmission of past policy rate reductions into banks’ lending rates post demonetisation should help encourage both consumption and investment demand of healthy corporations. Above all it expects various proposals in the Union Budget should stimulate capital expenditure, rural demand, and social and physical infrastructure all of which would invigorate economic activity. Fourth, the imminent materialisation of structural reforms in the form of the roll-out of the GST, the institution of the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board will boost investor confidence and bring in efficiency gains. Fifth, the upsurge in initial public offerings in the primary capital market augurs well for investment and growth, it said.