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RBI monetary policy: Will the central bank again spring a surprise?

06 February, 2017

As the Reserve Bank of India’s monetary policy committee begins its first rate-setting meeting of 2017 on Tuesday, the question on top of the mind of most investors is this: will it or won’t it?

In its October policy review—Urjit Patel’s first as governor—the RBI had sprung a surprise by cutting interest rates by 0.25%, when few expected it to do so. In December, just a month after Rs 500 and Rs 1,000 currency notes were banned, it kept the repo rate unchanged at 6.25%, when most expected it to trim rates.

So, what could the RBI do this time around?

A survey of economists from 10 banks conducted by the Mint newspaper says that slowing inflation and a fiscally responsible budget could prompt the RBI to cut interest rates. The report said that seven of the 10 economists expected the central bank to cut interest rates to 6%, while the other three said that the repo rate would remain unchanged.

In another report, The Economic Times said that a survey of 18 market participants suggests a rate cut is likely.

However, a report by the Indo-Asian News Service on Sunday said that the industry expects the RBI to hold rates in the wake of the fact that banks were flush with liquidity and that global oil prices were firming up. Lending rates have fallen by as much as one percentage point following the 8 November decision to outlaw 86% of the currency that was in circulation back then.

Citing industry lobby group the Federation of Indian Chambers of Commerce and Industry (FICCI), the report said that the RBI is likely to hold rates this time around but go in for a cut in the next financial year, which begins on 1 April.   

But is there a strong case for a rate cut?

One reason some economists feel the RBI could possibly cut interest rates is that the US Federal Reserve has indicated that it will pause on interest rates. A cooling off in inflation at home will help, too; retail inflation decelerated to a two-year low of 3.41% in December. 

The Mint newspaper said that slow credit growth and a contraction in the services sector for a third straight month in January, as noticed in the purchasing manager’s index numbers, could force the RBI to cut rates this time. 

Yet, why do some expect the central bank to hold rates?

One major factor forcing the RBI’s hand could be rising oil prices. In fact, even the Economic Survey, released just a day before last week’s annual budget, pointed out how the price of the Indian basket of crude oil had gone from just under $40 a barrel in April 2016 to more than $52 a barrel in December, and that such a movement posed an upside risk to the economy.

The Indian basket of crude oil is now at $55 a barrel. If oil prices keep inching higher, the RBI may again be confronted with the spectre of inflation, forcing it to hold rates.

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RBI monetary policy: Will the central bank again spring a surprise?

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