The Reserve Bank of India on Tuesday kept key interest rates unchanged at 6.75%, in line with market expectations saying that it awaits further data on the development of inflation and the impact from the 7th Central Pay Commission which has recommended wage hikes.
The central bank said it continues to be accommodative and awaits structural reforms in the forthcoming Union Budget which will boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5% by the end of 2016-17.
Unveiling the sixth bi-monthly monetary policy review, the RBI also said it will keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4% of net demand and time liability.
“Inflation has evolved closely along the trajectory set by the monetary policy stance. Going forward, under the assumption of a normal monsoon and the current level of international crude oil prices and exchange rates, inflation is expected to be inertial and be around 5% by the end of fiscal 2016-17. However, the implementation of the VII Central Pay Commission award, which has not been factored into these projections, will impart upward momentum to this trajectory for a period of one to two years. The Reserve Bank will adjust the forecast path as and when more clarity emerges on the timing of implementation,” said RBI.
Over the past year since last January, the RBI has cut the repo rate by 125 basis points bringing it to the current level of 6.75%. A basis point is one-hundredth of a percentage point. The last rate cut was in September 2015 when the RBI surprised the market with a 50-basis-point cut in the repo rate.
The benchmark repo rate is the rate at which banks borrow short term funds requirement from the RBI. This forms the basis for commercial banks to set their interest rates. Any cut in the repo rate should ideally translate into a corresponding cut in interest rates on home loans and other loans.
However banks take time in transmitting RBI’s cut, due to various factors, including lack of adequate capital for banks and mounting bad debts.
On inflation, RBI’s assessment on Tuesday said: “Retail inflation measured by the consumer price index (CPI) rose for the fifth month in December across all constituent categories. While the upturn in December essentially reflected unfavourable base effects, the ongoing seasonal decline in prices of fruits and vegetables could temper headline inflation in the near-term.”
Any move to cut interest rates is based on inflationary trends. Both Wholesale Price Index (WPI)-based inflation and Consumer price index (CPI)-based retail inflation have been on a rising trend in the last four months. In December, WPI-based inflation stood at (-)0.73%, while retail inflation moved up to 5.61%.
Higher salaries as recommended by the 7th Pay Commission would also typically imply more money in the system, a classic case to fuel inflation. A report by Citibank chief economist Samiran Chakraborty had recently estimated that the Pay Commission’s recommendations could add 50 basis points to retail inflation or CPI.