Monetary Policy: RBI maintains status quo

As was widely expected by bankers, economists and treasury market experts, the Reserve Bank of India maintained status quo on its policy rate in its second bi-monthly monetary policy review on Tuesday.

This comes in the backdrop of the retail inflation picking up in April, likelihood of the US Fed hiking its rates later this month, and the need to get more clarity on the outturn of the delayed monsoon.

The policy (repo) rate (the interest rate at which banks borrow short-term funds from RBI to tide over short-term liquidity mismatches) stands at 6.50 per cent.

The central bank last cut the repo rate by 25 basis points from 6.75 per cent to 6.50 per cent in the first bi-monthly monetary policy review on April 5.

Inflation surprise

In a statement, the RBI reasoned that "The inflation surprise in the April reading makes the future trajectory of inflation somewhat more uncertain...In addition, capacity utilisation indicators suggest that the available headroom in industry could keep output prices subdued even as demand picks up."

Nonetheless, the RBI said there are upside risks – firming international commodity prices, particularly of crude oil; the implementation of the 7th Central Pay Commission awards which will have to be factored into projections as soon as clarity on implementation emerges; the upturn in inflation expectations of households and of corporates; and the stickiness in inflation excluding food and fuel.

Outlook

Taking these factors into account, the inflation projections given in the April policy statement are retained, though with an upside bias. Considerable uncertainty surrounds these projections, which should be clarified by incoming data in the next few months, it added.

According to the central bank, incoming data since the first bi-monthly monetary policy review in April show a sharper-than-anticipated upsurge in inflationary pressures emanating from a number of food items (beyond seasonal effects), as well as a reversal in commodity prices.

"A strong monsoon, continued astute food management, as well as steady expansion in supply capacity, especially in services, could help offset these upward pressures. Given the uncertainties, the Reserve Bank will stay on hold, but the stance of monetary policy remains accommodative," it said.

Retail inflation, measured by the consumer price index (CPI), jumped to 5.39 per cent in April 2016, against 4.83 per cent in the previous month. For the RBI, CPI is the nominal anchor for making monetary policy.

The status quo on the rate should also be seen in the context of Subramanian Swamy, the newly nominated BJP Rajya Sabha Member of Parliament, being critical of RBI Governor Raghuram Rajan, blaming him for the collapse of the industry and rise of unemployment in the economy.

The mercurial BJP leader has alleged that the Governor, who was appointed by the previous UPA government, has hiked interest rates in the garb of controlling inflation, which has damaged the country.

Rajan, however, seems to enjoy the support of Prime Minister Narendra Modi and Finance Minister Arun Jaitley.

Rajan's three-year tenure at the helm of RBI comes to an end in September and there is uncertainty on whether the government will grant him an extension. There are reports that he may not want to continue as Governor even if given an extension.

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