IN: Reserve Bank of India

October 4, 2016 04:00 CDT

Consensus Actual Previous
Change 0bp -25bp 0bp
Level 6.50% 6.25% 6.50%

The Reserve Bank of India eased monetary policy settings at its meeting concluded today, contrary to the consensus forecast for no change. The benchmark repo rate was cut by 25 basis points to 6.25 percent, while the reverse repo rate was lowered by the same amount to 5.75 percent. Other policy instruments were also lowered by 25 basis points, with the marginal standing facility rate and bank rate now at 6.75 percent.

The statement accompanying this decision noted a sharper-than-anticipated slowdown in global growth, but some recovery in commodity prices. Turning to the domestic economy, officials argued that the outlook for the agricultural sector had improved after a relatively positive monsoon season, offsetting weakness in the manufacturing sector. They also noted that strong public spending, including higher wages for government employees, would likely support the growth outlook.

Despite a food-driven spike in consumer inflation in recent months, officials expressed confidence that favorable crop conditions and government efforts to ease supply pressures for key food items would help keep headline inflation contained. Officials forecast headline CPI inflation to settle around 5.0 percent by the end of the fiscal year in March 2017, and they also argue that upside risks to this forecast have eased since the last policy statement in August. This, they argued, has "opened up space" for the easing of policy announced today.

This month's meeting was the first chaired by newly-appointed RBI Governor Urjit Patel, and was also the first for the newly-constituted Monetary Policy Committee under a new policy framework announced earlier this year. Previously, monetary policy in India was determined solely by the RBI Governor, acting on the advice of a technical committee of experts.

The new six-member MPC consists of the Governor and two other RBI officials, as well as three external members appointed by the government. Policy settings are now decided by a majority vote, with the Governor having a casting vote in the event of a tie. The MPC is to meet at least four times each year.

The policy objective of the MPC for the next five years is to target consumer inflation at 4.0 percent, with a tolerance band of between 2.0 percent and 6.0 percent. If average inflation is outside this tolerance band for any three consecutive months, the RBI is considered to have breached its target. If this happens, the RBI will be required to provide a report to the government outlining the reasons for this breach, how it intends to get inflation back within the tolerance band, and how long it thinks this will take. At the start of this new policy framework, the most recent CPI data showed consumer inflation inside the tolerance band at 5.05 percent in August, down from 6.07 percent in July.

The Reserve Bank of India (RBI) issues six Bi-monthly Policy Statements a year. During these announcements the RBI will signal any shifts in its monetary stance, particularly with reference to the benchmark repo interest rate and its cash reserve ratio (CRR). The Governor will also update the Bank's view of recent economic developments and provide new forecasts for inflation and growth. A 4 percent inflation target with a +/- 2 percentage point tolerance band was formally implemented in August 2016 and will be overseen by a new six-member Monetary Policy Committee (MPC).

Although the RBI monitors many economic indicators - as indeed all central banks do - the RBI most closely monitors inflation. The level of interest rates affects the economy. Higher interest rates tend to slow economic activity while lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, fewer homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or for those who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India. The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the Government of India in keeping with the Reserve Bank of India Act.

The Reserve Bank of India performs this function under the guidance of the Board for Financial Supervision (BFS). The Board was constituted in November 1994 as a committee of the Central Board of Directors of the Reserve Bank of India. Primary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies. Its function is to advise the Central Board on local matters and to represent territorial and economic interests of local cooperative and indigenous banks; to perform such other functions as delegated by Central Board from time to time. Primary objective of BFS is to undertake consolidated supervision of the financial sector comprising commercial banks, financial institutions and non-banking finance companies. The Board is required to meet normally once every month. It considers inspection reports and other supervisory issues placed before it by the supervisory departments.