India Monetary Policy


Reserve Bank cuts interest rates in surprising move

In an unscheduled meeting on 15 January, the Reserve Bank of India (RBI) took the surprising decision to cut the repurchase rate from 8.00% to 7.75%. In order to maintain the corridor at which monetary policy rates move, the Bank also decided to reduce the marginal standing facility rate (Bank rate) by 25 basis points to 8.75% and also reduced the reverse repurchase rate by 25 basis points to 6.75%. Many market analysts had expected the Central Bank to cut interest rates as early as Q2 2015.

Commenting on the decision, the Central Bank recognized that inflation has been easing since July 2014 and that it has hovered below the Bank’s expected trajectory. Monetary authorities explained that lower-than-expected inflation stemmed from the persistent fall in food prices as well as sharp decreases in global commodity prices, notably oil prices. In fact, the Bank acknowledged that it expects lower oil prices throughout this year. The RBI stated that weak economic conditions have also contributed to reducing inflationary pressures. Finally, the Bank commented that the government’s commitment to adhere to its fiscal targets has caused inflation to moderate.

Regarding inflation expectations, the Central Bank pointed out that prospects in both the near- and long-term, “have adapted and eased to single digits for the first time since September 2009.” In addition, the RBI stated that the current inflation rate remains below the 8.0% inflation target for January 2015. The Bank expects inflation to fall further below the 6.0% inflation target for January 2016. Against this backdrop, the Bank decided to reduce the monetary policy rate and recalled the assessment made in its December 2014 meeting, during which it noted that, “if the current inflation momentum and changes in inflation expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.” Finally, monetary authorities commented that subsequent monetary policy actions will be subject to data confirming further “disinflationary pressures”. The next scheduled monetary policy meeting will take place on 2 February.

Regarding the Central Bank’s decision, Radhika Rao and Eugene Leow, Economists at DBS Bank commented:

The RBI has been wary of policy flip-flops, as the Governor said back in December that as and when policy direction shifts, subsequent action should be ‘consistent with the changed course’. This suggests that Thursday’s move is unlikely to be an one-off (barring the small probability of a sharp reversal in crude prices). February’s review will be a non-event after Thursday’s cut. We look for another 50bps cuts in the June quarter and steady thereafter, provided the pre-conditions of fiscal correction, tabling of a reform-friendly budget and waning inflation trajectory hold. The narrowing (domestic) output gap and shifts in the US rate hike expectations are the key risks in the horizon.

FocusEconomics Consensus Forecast panelists are still taking these developments into account and project that the repurchase rate will average 7.84% at the end of FY 2014/2015. For FY 2015/2016, panelists see the repurchase rate ending the year at 7.40%.

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India Monetary Policy Chart

India Monetary Policy January 2015

Note: Marginal Standing Facility (MSF) Rate, Repo Rate and Reverse Repo Rate in %.
Source: Reserve Bank of India (RBI).

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