RBI keeps its door open to cut rates, is watchful of incoming data

Pause for now, keeps policy stance neutral with 5-to1 vote to maintain status quo in interest rates

The six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) on Wednesday voted five-to-one to keep interest rates unchanged, preferring to remain watchful of incoming data.

Ravindra Dholakia, an external member of the MPC and professor at the Indian Institute of Management, Ahmedabad, was the dissenting voter.

Even as the central bank’s official policy stance continued to remain "neutral", the language used by RBI officials gave the impression to the market that the central bank had embraced an accommodative stance once again. The central bank kept the possibility of a future rate cut open as a “premature action at this stage risks disruptive policy reversals later and the loss of credibility”.

The stance was changed from accommodative to neutral in the last policy in February.

Retail inflation at 2.99 per cent in April “surprised on the downside and imparted high uncertainty to the (RBI inflation) outlook,” Urjit Patel, RBI governor, said in his opening remarks at the policy press conference.

The RBI now expects consumer price inflation (CPI) in the range of 2-3.5 per cent in the first half of the fiscal year and 3.5-4.5 per cent in the second half. Earlier, the central bank was expecting an average 4.5 per cent in the first half and 5 per cent in the second half.

“We will watch carefully in next few months the incoming data on inflation as well as the indicators of real economic activity,” said Viral Acharya, RBI deputy governor in charge of monetary policy.

The impact of demonetisation on food prices still lingered on and there was a supply glut in pulses, the central bank said.

“The current state of the economy underscores the need to revive private investment, restore banking sector health and remove infrastructural bottlenecks. Monetary policy can play a more effective role only when these factors are in place,” the policy document said.

Patel once again warned against farm debt waivers. “Unless there is an existing fiscal space in state government budgets or some space is found, the likelihood of going down this slippery path and dissipating the important gains that we have made in fiscal rectitude over the last two to three years can come undone,” he said.

“Past episodes in our country have shown that when there are significant fiscal slippages, they permeate through to inflation sooner or later. It is a path that we need to track very carefully before it gets out of hand,” he added.

Acharya urged banks to pass on benefits of lower rates. But bankers said they had done what they could.

“Banks have played their role in effective monetary policy transmission by downward revision of their lending rates. However, the demand for credit is yet to pick up. Growth is the result of many more complex factors and not the repo rate alone,” said R P Marathe, CEO and MD of Bank of Maharashtra.

The market interpreted the policy as “quite a dovish one” with adequate hints of rate cuts in the future. Analysts were largely expecting the repo rate to remain at the current 6.25 per cent for an extended period, at least for the whole of 2017. Now that assumption could be tested.

“In our view, policy rates could remain unchanged in the foreseeable future if it is indeed strict inflation targeting that the RBI is pursuing,” said Abheek Barua, chief economist, HDFC Bank.

“However, it could also be the case that the RBI is reluctant to change its stance too soon. Therefore, if the monthly inflation momentum moves closer to the lower end of the RBI’s projected path, then a rate cut cannot be ruled out,” Barua said.

Yields on the 10-year gilt closed at 6.56 per cent, down from their previous close of 6.64 per cent, as rate cut hopes increased after the RBI policy. The rupee closed 0.15 per cent stronger at 64.33 to a dollar.

The central bank also lowered the 2017-18  gross value added estimate by 10 basis points to 7.3 per cent.

In continuation with its earlier practice of lowering mandatory bond holdings by banks to improve the liquidity coverage ratio to 100 per cent, the central bank cut the statutory liquidity ratio by 50 basis points to 20 per cent of a bank’s deposit base.

The RBI also wanted rupee denominated bonds or masala bonds to be harmonised with external commercial borrowing norms and therefore imposed restrictions on maturity, all-in-one cost ceiling and entities who could invest in these.

The central bank reduced the risk weights and provisioning on housing loans, which should help lower home loan interest rates.