RBI Policy Update – Lower Rates & MPC

The RBI released its fourth bi-monthly monetary policy statement for 2016-17. This was the first statement released under the new Governor, Urijit Patel. Things to note:

  • The RBI cut the repo rate from 6.5% to 6.25%, despite the inflation forecast for fiscal 2018 going over target.
  • The RBI also lowered its its real interest rate (i.e the nominal interest less the inflation) target to 1.25%, from the 1.5-2% band set by former RBI Governor Raghuram Rajan. This opens up room to cut rates further down the road.
  • The RBI also indicated that the timeline for meeting its inflation target, has been stretched to end of 2021.
  • Till now, a technical advisory committee used to advise the RBI Governor on monetary policy, but he wasn’t obliged to follow the advise. From now on, the policy interest rate will be “democratized” in some sense, via the Monetary Policy Committee (of which the Governor will be a member), which will decide the interest rates. This is because RBI was mandated from August ’16 onward to keep consumer inflation at 4% in the next 5 years with a margin of 2% on either side in the monetary policy framework agreed with the government.

Overall, the Governor has started his term on a dovish note. The yield on the benchmark bond fell from 6.773% to 6.732% on 4th October, and further fell to 6.674% by 5th October before recovering to 6.735%. The market expectation based of fallen yields (so far, 2016 has seen yields fall by 108 bps) is that there could be more rate cuts moving forward, coupled with RBI’s lowered real interest rate target.

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