India: Reserve Bank holds repurchase rate steady at Rajan's final meeting
August 9, 2016
At a scheduled meeting on 9 August, the Reserve Bank of India (RBI) decided to keep the repurchase rate unchanged at an over-five-year low of 6.50%, meeting market expectations. Accordingly, the Bank also decided to keep the marginal standing facility rate (Bank Rate) unchanged at 7.00% and the reverse repurchase rate steady at 6.00%. The meeting marked the final decision helmed by RBI Governor Raghuram Rajan.
In the accompanying statement, the Bank outlined that the decisions were driven by increased upside risks to the inflation projection. A sharper-than-expected seasonal rise in food prices has pushed up the Bank’s projected trajectory of prices. In addition, uncertainty over the evolution of fuel prices and how a hike in public sector wages will affect inflation expectations are elevating risks to the inflation outlook. Accordingly, the Bank decided to, “keep the policy repo rate unchanged at this juncture, while awaiting space for monetary easing.”
Despite the increased upside risks, the RBI maintained an accommodative stance in its forward guidance. In addition, the Bank emphasized that it will continue to pursue easy liquidity conditions and to promote interest rate pass-through to the economy. The next monetary policy meeting is scheduled for 4 October.
Rajan will finish his term as governor on 4 September, passing future monetary policy decisions to a new governor. On top of this, a new rate-setting panel will be established in one of the largest overhauls of the RBI. Rajan has been instrumental in modernizing India’s monetary policy framework. The Central Bank’s nominees to the new six-member monetary policy committee were announced along with the interest rate decision. The government still has to choose its three representatives for the panel. Meanwhile, the government recently extended the inflation target of 4.0% plus or minus 2.0 percentage points through to FY 2020. Commenting on the future direction of monetary policy, Sonal Varma, economist at Nomura adds:
“With 4% given as the inflation target for the next five years, room for accommodative policy has largely been used up, in our view because we do not expect sustained disinflation below 5% due to elevated inflation expectations and bottlenecks in infrastructure and agriculture. Moreover, with housing rent allowances (under the pay commission) and the likely implementation next year of the goods and services tax, risks to inflation, although transitory, are to the upside. As such, we pencil in a 25bp cut in Q4 2016 but assign only a 65% probability to it, as it is largely centred on the expectation of a dovish monetary policy committee (MPC) and RBI governor, rather than an undershoot of inflation.”