IN: Reserve Bank of India

February 8, 2017 03:00 CST

Consensus Actual Previous
Change -25bp 0bp 0bp
Level 6.00% 6.25% 6.25%

The Reserve Bank of India left its main policy rate, the repurchase rate, unchanged at 6.25 percent, contrary to the consensus forecast for a cut of 25 basis points. This rate was cut by that amount in October and April last year. The decision to keep rates on hold was agreed to by all six of the members of the Monetary Policy Committee, with officials arguing that the current policy stance is consistent with their medium-term goal of keeping headline inflation in a target range of 2.0 percent to 6.0 percent. The MPC also shifted its characterisation of the policy stance from accommodative to neutral, suggesting the chances of a rate cut in coming months has also diminished.

As was the case in December, a rate cut was widely anticipated today in response to monthly data, particularly PMI surveys, showing a clear slowdown in activity since November. This was largely driven by cash shortages in the economy after the government announced early in November that it would withdraw high-denomination notes as legal tender as part of efforts to curb tax avoidance and corruption.

At the time of its December policy review, officials at the RBI concluded that it was appropriate to "look through the transitory but unclear effects" of the government's decision, suggesting that the impact could be temporary and limited. PMI surveys for January, published last week, showed that conditions in both the manufacturing and services sectors remain subdued but had improved from the initial impact in November and December.

In the statement accompanying today's decision, the RBI argued that liquidity conditions have "re-balanced" in recent weeks, with an expansion of currency in circulation and new bank notes being injected into the system "at an accelerated pace". This appears to have eased cash shortages and improved sentiment. As a result, officials argue that consumer spending and, more generally, economic activity in cash-intensive sectors, is likely to rebound quickly. Reflecting this assessment, officials forecast India's economy to grow by 6.9 percent in the current fiscal year, ending in March, and by 7.4 percent in the next fiscal year starting in April. Given this growth outlook, officials concluded that the economy does not require additional policy support.

Instead, the statement makes clear that the main concern for the RBI right now is the inflation outlook. Officials noted that headline CPI inflation moderated in November and December but argue that this was primarily driven by sharp falls in the price of vegetables and pulses, which appears to have been driven by distress sales of perishable items caused by the cash shortages. Although this means that headline CPI inflation will likely fall short of the RBI's near-term target of 5.0 percent by the end of this fiscal year, it is now too late for policy to have much of an impact on this and officials therefore are more concerned about keeping inflation around 4.0 percent, the mid-point of their medium-term target range of 2.0 percent to 6.0 percent.

Officials currently expect inflation to increase to around 4.5 percent to 5.0 percent in the second half of next fiscal year but also identify significant upside risks to this forecast, including higher oil prices, exchange rate volatility and increased labour costs. Given this outlook, MPC members clearly saw little case for a rate cut today and look likely to remain wary about easing policy in coming months unless the inflation outlook improves. Indeed, should incoming activity data provide further evidence that the impact of the government's currency decision is short-lived, officials may start to consider the case for a rate hike in order to dampen price pressures. The RBI's next policy review is scheduled for April 5 and 6.

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.