RBI keeps rates unchanged, warns against higher inflation, fiscal deficit

The RBI panel said there have been several significant developments in the recent period which augur well for growth prospects, going forward.

Written by George Mathew | Mumbai | Updated: December 7, 2017 8:06 am
RBI Governor Urjit Patel with deputies B P Kanungo, N S Vishwanathan and Viral V Acharya in Mumbai. (Ganesh Shirsekar)

Lending and deposit rates are expected to remain unchanged as the Reserve Bank of India (RBI) on Wednesday kept key policy rates unchanged, while flagging off the risk of an uptick in both inflation and fiscal deficit.

A moderation in inflation, excluding food and fuel, observed in the first quarter of 2017-18 has, by and large, reversed and “two of the key factors determining the cost of living conditions and inflation expectations — food and fuel inflation — edged up in November”.

“There is a risk that this upward trajectory may continue in the near term,” RBI Governor Urjit Patel warned after the monetary policy review. Stock markets were unnerved by the higher inflation projection with the Sensex plunging 205 points to end at 32,597.18, while the broader Nifty finished at 10,044.10, down 74.15 points.

The RBI warned that implementation of farm loan waivers by select states, partial rollback of excise duty and VAT in the case of petroleum products, and decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant implications for inflation. India’s fiscal deficit already rose to 96.1 per cent of the full-year target by the end of October as receipts lagged behind expenditure. The revenue deficit overshot the full-year target by 24.7 per cent between April and October. It was much lower at 92.5 per cent of the budget estimate a year ago.

The six-member Monetary Policy Committee (MPC) of the central bank kept the main policy rate — repo rate, or the rate at which it lends funds to banks — unchanged at 6 per cent and reverse repo rate at 5.75 per cent. However, the decision was not unanimous as five members — Chetan Ghate, Pami Dua, Michael Debabrata Patra, Viral V Acharya and Urjit R Patel — were in favour of keeping the repo rate steady, while Ravindra H Dholakia voted for a policy rate reduction of 25 basis points.

Markets and analysts were widely expecting the RBI to keep the rates steady as the year-on-year (YoY) consumer price inflation rose to a seven-month high of 3.6 per cent in October 2017 from 3.3 per cent in September 2017. The RBI has cut repo rate by 200 basis points since January 2014, but transmission of the rate cut has been very slow with banks going in for steep deposit rate cuts while going slow on lowering lending rates. The RBI last cut the repo rate by 25 bps to 6 per cent in the August 2017 review.

The RBI panel said there have been several significant developments in the recent period which augur well for growth prospects, going forward. “First, capital raised from the primary capital market has increased significantly after several years of sluggish activity. Second, the improvement in the ease of doing business ranking should help sustain foreign direct investment in the economy. Third, large distressed borrowers are being referenced to the insolvency and bankruptcy code (IBC) and public sector banks are being recapitalised, which should enhance allocative efficiency,” the MPC said in its resolution.

Revising the inflation projection upwards, MPC said inflation is estimated in the range of 4.3-4.7 per cent in the third and fourth quarters of this year, including the HRA (house rent allowance) effect of up to 35 basis points, with risks evenly balanced. Two months ago, it had projected inflation to rise and range between 4.2-4.6 per cent in the second half of this year.

The expected seasonal moderation in prices of vegetables and fruits, and the recent lowering of tax rates by the GST Council could mitigate upside pressures, the MPC said. “Accordingly, the MPC decided to keep the policy repo rate on hold. However, keeping in mind the output gap dynamics, the MPC decided to continue with the neutral stance and watch the incoming data carefully. The MPC remains committed to keeping headline inflation close to 4 per cent on a durable basis,” it said.

However, it retained the growth forecast at 6.7 per cent for 2017-18 even through the gross value added (GVA) in the second quarter rose to 6.3 per cent. On growth projections, the RBI committee said second quarter growth was lower than that projected in the October resolution. The recent increase in oil prices may have a negative impact on margins of firms and GVA growth, it said. The central bank projected a growth rate of 7.3 per cent and 7.8 per cent in the third and fourth quarters.

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