The Reserve Bank of India left its main policy rate, the repurchase rate, unchanged at 6.25 percent, in line with the consensus forecast. The last time this rate was changed was October last year, when it was lowered by 25 basis points. Officials, however, have increased another policy instrument, the reverse repo rate, by 25 basis points to 6.0 percent.These decisions were agreed to by all six of the members of the Monetary Policy Committee. The MPC also retained its characterisation of the policy stance as "neutral".
Recent data suggest that India's economy has rebounded from a slowdown in activity late last year. This was largely driven by cash shortages in the economy after the Indian 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. PMI survey data for both the manufacturing and services sectors have shown stronger activity since the start of the year, while industrial production also rose on the year in January after a small drop in December.
This is broadly consistent with the argument made by officials at previous policy meetings that the impact of the government's decision on economic activity should be "transitory". Officials forecast India's economy to have grown by 6.7 percent in the fiscal year just ended, and to grow by 7.4 percent in the fiscal year that began at the start of the month.
These growth forecasts suggest that the inflation outlook is now the main focus for officials. Although headline inflation and food prices had weakened since mid-2016, reflecting the impact of favourable rainfall during the monsoon season and then the impact of cash shortages, officials expected that this moderation in price pressures would not last long. February CPI data released last month showed a marked acceleration in both food price inflation and headline inflation, with the overall CPI increasing by 3.65 percent on the year, up from 3.17 percent in January. Officials expect inflation to average around 4.5 percent in the first half of the new fiscal year and 5.0 percent in the second half but have also identified significant upside risks to this forecast, including higher oil prices, exchange rate volatility and increased labour costs.
Given this outlook, MPC members clearly see little case for policy rates to be cut any further for now. Instead, the decision to increase the reverse repo rate suggests that officials see a stronger case for a broader tightening of policy in coming months should growth and inflation data develop in line with their forecasts. The RBI's next policy review is scheduled for June 6 and 7.
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.