IN: Reserve Bank of India

Wed Aug 02 04:00:00 CDT 2017

Consensus Actual Previous
Change -25bp -25bp 0bp
Level 6.0% 6.0% 6.25%

The Reserve Bank of India has lowered its main policy rate, the repurchase rate, by 25 basis points to 6.00, in line with the consensus forecast. The reverse repurchase rate was also lowered by 25 basis points to 5.75 percent, reversing the increase of 25 basis points made in April. These decisions were agreed to by four of the six members of the Monetary Policy Committee, with one member favouring no change and the other a cut of 50 basis points.

The RBI's policy statement makes clear that the recent sharp drop in headline inflation was the main focus of their policy deliberations. The RBI is forecasting average inflation to be between 2.0 percent and 3.5 percent in the first half of the fiscal year that started in April, increasing to between 3.5 percent and 4.5 percent in the second half. After rising earlier in the year, however, CPI inflation has fallen in recent months to just 1.54 percent in July, the lowest level in the series' history and below the RBI's target range of 2.0 percent to 6.0 percent.

Officials argue that it has been difficult to distinguish the extent to which this decline in headline inflation has been driven by transitory or structural factors. They note that much of the decline has been attributable to "large favourable base effects" which they expect to fade and reverse in coming months, implying that inflation will pick up again. They also believe that seasonal spikes in some food prices and a planned reduction in fuel subsidies will push up aggregate prices in the near-term. Pay increases planned for state government employees were also cited as a factor that could push up headline inflation above the the RBI's forecast.

Although officials remain concerned about these potential upside risks to the inflation outlook, they concede that other upside risks have either reduced or not materialised. In particular, they note that inflation excluding food and fuel has "fallen significantly" in the last three months, and that the implementation of the government's goods and services tax has been "smooth". This, they concluded, meant that "some space has opened up" to lower policy rates in response to recent weakness in some key activity indicators.

Although the recent moderation in price pressures was enough to prompt today's rate cut, the statement makes clear that officials still expect headline inflation to rise from its current low level. Reflecting this assessment, officials retained their assessment of the current policy stance as "neutral". This suggests that the near-term outlook for policy rates will depend heavily on whether or not incoming inflation data move in line with the RBI's forecasts.

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.