The Reserve Bank of India under governor Urjit Patel refrained from surprising investors for the first time since October by leaving the key policy rate unchanged, but waved a red flag on inflationary pressures that likely signal the end of lower borrowing costs.
At the same time, interest rates may not crawl up any time before next year as RBI has factored in enough bad news on the inflation front. Economic prospects are brighter due to the “wartime pace“ of remonetisation, the upcoming implementation of the goods and services tax and slashing of lending rates by banks, Patel said.
The Monetary Policy Committee, which voted unanimously for the fourth time in a row, did raise the reverse repo rate, at which RBI pays banks for excess deposits, by a quarter point. That was aimed at reducing the distortion to money market rates caused by a surge in liquidity due to flow of funds into banks after demonetisation, announced on November 8. The RBI raised both the economic growth and inflation forecasts for the fiscal year, and laid out measures to tackle surplus liquidity due to demonetisation and a likely surge in overseas fund flows that are making interest rate policy less effective. FY18 growth was pegged at 7.4%, up from 6.7% in the last fiscal. To improve credit flow to the economy , the bad loan burden of banks will be addressed on an urgent footing along with the government, but there is no room for any more regulatory forbearance, Patel said.
The narrowing output gap was also blamed for higher inflation expectations. Inflation is forecast to average 4.5% in the first half of this fiscal year and climb to 5%.That's against the target of 4%, with a margin of two percentage points on either side.
The repo rate, at which RBI lends to banks, remained at 6.25%. The difference between the repo rate and the Marginal Standing Facility rate, the penal rate, was cut by half to 25 basis points. The lower MSF rate will benefit banks in times of tighter liquidity when they have to borrow from RBI.
The MPC, which surprised investors at its last meeting in February with a shift in stance to neutral from accommodative, believes that upside risks to inflation are aplenty , ranging from the likely hit on food prices if the June-September monsoon fails, and the implementation of the house rent allowance recommendation of the seventh pay commission.