Week in monetary policy review : RBI focus on inflation

What happened

The Reserve Bank of India on 8th February 2017 kept its key policy rate or the repo rate (which is the short term lending rate) unchanged at 6.25 percent for the second time in a row. This was against the consensus view in the market hoping for a 25 bps rate cut. All other rates i.e reverse repo rate, the marginal standing facility rate and the bank rate, were left unchanged.

Key things RBI noted

The RBI said that this decision of the MPC is consistent with a neutral stance of monetary policy with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term (2 year) target of 4 per cent within a band of +/- 2 per cent, while supporting growth.

The RBI noted that while retail inflation measured by the CPI has come down for 5 consecutive months, this is driven mainly by deflationary price movements in food items (vegetables and pulses). However, the non-food , non-fuel inflation also needs to come down in order to achieve the target of bringing overall inflation below 5%.

Outlook regarding inflation

  • The MPC is of the view that persistence of inflation ex-food and ex-fuel could set a floor on further downward movements in headline inflation and trigger second-order effects.
  • For Q4 2016-17 headline CPI inflation is likely to be below 5 per cent.
  • Favorable base effects and lagged effects of demand reduction due to demonetization may mute headline inflation in Q1 of 2017-18. Thereafter, it is expected to pick up momentum, especially as growth picks up and the output gap narrows.
  • Base effects will reverse and turn adverse during Q3 and Q4 of 2017-18. Accordingly, inflation is projected in the range of 4.0 to 4.5 per cent in the first half of the FY and in the range of 4.5 to 5.0 per cent in the second half with evenly balanced risks on either side.
  • The MPC noted three significant upside risks to the baseline inflation path – the hardening of international oil prices; volatility in the FX rate due to global market developments, which could speed up domestic inflation; and the effects of the house rent allowances (HRA) under the 7th Central Pay Commission which have not been factored in the baseline inflation path.

What it means

Most major banks cut their lending rates in January post demonetization and inflow of cash reserves. With this policy review from RBI, banks may not cut rates further for a while.

 

This was the RBI’s sixth bi-monthly and last policy for the year 2016-17 and the third by the Monetary Polciy Committee (MPC). The next policy meet will be on April 5-6.

Here is the press release from RBI.

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