RBI Keeps Repo Rate Unchanged, Hikes Reverse Repo Rate By 25 bps

The RBI headquarters in Mumbai. (Photo: Reuters)

The monetary policy committee (MPC) on Thursday kept its benchmark repo rate unchanged citing the likelihood of higher inflation in the current fiscal year. The RBI, however, raised the reverse repo rate by 25 basis points to try and bring market rates closer to the policy rate at a time when surplus liquidity conditions persist.

Following Thursday’s policy review, the benchmark repo rate stands unchanged at 6.25 percent. The reverse repo rate has been hiked from 5.75 percent to 6 percent.

“The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, while supporting growth.”

The RBI maintained its neutral monetary policy stance saying that future rate action will depend on incoming data.

In explaining its decision to hike the reverse repo rate, the RBI said that a narrower interest rate corridor “can contribute to finer alignment of the operating target with the policy rate.” The central bank further added that liquidity would be progressively brought towards “neutrality” using all tools at its disposal.

The RBI is also working towards the introduction of a new facility known as the standing deposit facility (SDF) which will be used to suck out surplus liquidity. Through this facility, banks and other entities can park surplus funds with the regulator without the RBI having to offer collateral in return.

The introduction of this facility is under examination of the government, the RBI said, while adding that its introduction would give greater flexibility to the Reserve Bank to manage its liquidity operations.

Sharing its outlook for financial year 2017-18 in the accompanying monetary policy report, the RBI said that it expects inflation to pick up from current levels of 3.7 percent and hit 4.2 percent in the first quarter of the current year. It may rise further to 4.7 percent in the second quarter and briefly surpass 5 percent in the third quarter before coming down to near 4.9 percent by the March 2018.

The RBI did not specify the time period over which it intends to bring inflation down to the 4 percent central target set under the flexible inflation targeting framework. It however, said that this target would be achieved gradually and in a durable manner.

“Underneath current benign inflation conditions, there are broad-based inflation pressures, which make the inflation outlook for 2017-18 challenging,” said the RBI while adding that higher commodity prices, exchange rate volatility and higher house rent allowances under the seventh pay commission are key upside risks to inflation.

Meanwhile growth in the current fiscal is seen at 7.4 percent, said the central bank while adding that any temporary impact of demonetisation has abated.

Growth in real gross value added (GVA) is expected to accelerate in 2017-18, underpinned by strong consumption demand even as investment activity remains muted and external demand uncertain.

RBI Policy Statement

Most analysts expects growth to range between 7-7.5 percent in the current fiscal, marginally stronger than the 7.1 percent estimated for financial year 2016-17.

The central bank expects remonetisation and the government’s focus on capital expenditure and the rural housing segment to boost the outlook for growth.

The benchmark 10-year yield hardened to 6.743 percent after the policy from 6.696 percent just before the announcement.

The rupee was little changed at 64.93 against the US dollar versus 64.975 pre-policy. The Indian currency closed at 64.8825 on Wednesday.

The Bank Nifty dipped to a low of 21,488.9 post policy but quickly recovered from those levels to trade at 21,573.

(This story was originally published in BloombergQuint.)

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