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RBI keeps rates unchanged on inflation fears

07 June, 2016

The Reserve Bank of India kept interest rates on hold at a five-year low on Tuesday, as was widely expected, after inflation showed signs of acceleration and India retained its position as the world’s fastest-growing large economy.

RBI governor Raghuram Rajan, at the centre of a public debate whether the government will extend his tenure when it ends in September, maintained the repo rate—at which it lends to banks—at 6.5% and the cash reserve ratio—the amount of deposits banks must keep with the RBI—unchanged at 4%.

“The inflation surprise in the April reading makes the future trajectory of inflation somewhat more uncertain,” Rajan said in the policy statement. 

Inflation has been accelerating over the past few weeks. According to government data, wholesale prices in India rose in April after falling for 17 months as vegetables and pulses turned costlier while retail inflation accelerated to 5.39% from March’s 4.83%. 

Rajan also said that domestic conditions for growth are improving gradually, mainly driven by consumption demand, which is expected to strengthen with a normal monsoon and the implementation of the Seventh Pay Commission award. 

However, business confidence will be restrained to an extent on account of unrelenting global factors. “On a reassessment of balance of risks, therefore, the GVA (gross value added) growth projection for 2016-17 has been retained at 7.6% with risks evenly balanced,” he said.

India’s gross domestic product expanded quarter, pushing growth for the full financial year 2015-16 to a five-year high of 7.6%, the Central Statistics Office said last week. Growth in GVA was 7.2% for 2015-16.

The RBI’s policy statement “broadly endorses government expectations on GDP growth and inflation,” economic affairs secretary Shaktikanta Das tweeted.

More rate cuts?

The central bank has lowered the repo rate by 150 basis points since January 2015. This includes the 25-basis-point reduction in its last policy review in April.

On Tuesday, the RBI said that strong monsoon rainfall, astute food management and expansion in supply capacity could help offset inflationary pressures. It added that it will stay on hold given the uncertainties but the stance of monetary policy “remains accommodative”.

Economists, however, are divided over whether and when the RBI will cut rates next.

Marie Diron, senior vice president, Sovereign Risk Group, Moody’s Investors Service, Singapore, said the ratings firm doesn’t expect a significant change in the monetary policy stance. “Rather, the transmission of monetary policy will influence India’s economic developments and credit profile,” Diron said.

Taimur Baig, chief economist at Deutsche Bank, and Nomura India economist Sonal Varma feel there is little room for rate cuts due to inflation concerns. However, HDFC Bank chief economist Abheek Barua and India Ratings and Research feel there is room for a 25-basis-point cut in the current financial year.

Rana Kapoor, managing director and CEO, YES Bank, said the RBI remained cautious despite a favourable monsoon outlook, retail inflation in line with projections, government’s reforms and fiscal consolidation. But he is optimistic of a rate cut at the RBI’s next policy review on August 9. “With its accommodative stance still in place, I now see high probability of a rate cut in August by at least 50 basis points,” he said.

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RBI keeps rates unchanged on inflation fears

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