IN: Reserve Bank of India

June 7, 2017 04:00 CDT

Consensus Actual Previous
Change 0bp 0bp 0bp
Level 6.25% 6.25% 6.25%

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 reverse repurchase rate was also left unchanged at 6.0 percent after it was increased by 25 basis points at the last policy meeting in April. These decisions were agreed to by five of the six members of the Monetary Policy Committee. The MPC also retained its characterisation of the policy stance as "neutral".

The RBI's policy statement, however, makes clear that officials have been surprised by the latest inflation data, which show an "abrupt and significant retreat of inflation in April from the firming trajectory that was developing in February and March." Headline CPI inflation fell from 3.81 percent in March to 2.99 percent in April - well below the mid-point of the RBI's target range of 2.0 percent to 6.0 percent - while headline WPI inflation dropped from 5.30 percent to 3.85 percent. Excess supply for certain food items have largely driven this drop in inflation.

Officials had previously forecasted headline CPI inflation to average around 4.5 percent in the first half of the current fiscal year and 5.0 percent in the second half, with risks skewed to the upside. Now, however, they believe inflation is on track to average between 2.0 percent and 3.5 percent in the first half and between 3.5 percent and 4.5 percent in the second half, with risks "evenly balanced".

Recent activity data have also provided mixed signals about the strength of India's economy after a sharp slowdown late last year. This slowdown was largely driven by cash shortages in the economy after the Indian government announced 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 show that activity has rebounded strongly since the start of the year, but industrial production and gross domestic product data for the first three months of the year show weaker growth. Reflecting these developments, the RBI still expects growth to pick up from 6.7 percent last fiscal year but has now revised down its growth forecast for the current fiscal year from 7.4 percent to 7.3 percent.

At its previous policy review in April the RBI had identified upside risks to inflation as a serious concern and signalled that the policy bias could be shifting in favour of a higher repurchase rate. Today's statement, however, makes clear that inflation concerns have now been replaced with a more cautious view of the outlook. In particular, the statement stresses that "premature action at this stage risks disruptive policy reversals later and the loss of credibility", suggesting that recent stability in the main policy rate looks set to continue in the near-term. The RBI's next policy review is scheduled for August 1 and 2.

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.