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Monetary policy meeting: 3 reasons why RBI may not cut rates

RBI’s monetary policy committee is likely to keep interest rate unchanged noting several upside risks to inflation

business Updated: Feb 06, 2018 17:03 IST
A Reserve Bank of India (RBI) logo is seen at the entrance gate of its headquarters in Mumbai.
A Reserve Bank of India (RBI) logo is seen at the entrance gate of its headquarters in Mumbai.(Reuters)

The Reserve Bank of India’s (RBI) monetary policy committee (MPC) is likely to keep interest rate unchanged noting several upside risks to inflation.

Fourteen of the 15 economists surveyed by Mint expect RBI to keep the repo rate—the rate at which the central bank lends to banks—unchanged at 6%. One basis point is a hundredth of a percentage point. One economist expects a 25 basis point hike.

Here are the reasons why the central bank may keep rates on hold:

Inflation: Retail inflation, as measured by the Consumer Price Index (CPI), has already breached 4%, the RBI’s medium-term target, for two consecutive months. Rising oil prices and lingering impact of rise in house rent allowance, as part of the 7th Pay Commission, are likely to keep future inflation prints elevated. Additionally, some economists are also pricing in potential impact of the budget announcement of minimum support price (MSP) of agricultural commodities on inflation. “Details are scant at the point of writing, though in the past, instances of a sharp increase in MSPs have coincided with high food inflation, spurring concerns over generalized price pressures. The RBI will thereby flag the projected fiscal slippage, oil and higher MSPs as risk factors,” said Radhika Rao, economist at DBS Bank.

Oil prices: Higher oil prices have been one of the key factors contributing to the rise in inflation. Further rise in prices will not only impact inflation but also other indicators such as current account deficit as well as growth because India is the net importer of oil. According to US Energy Information Administration (EIA), the price of Brent crude oil, an international benchmark, which averaged $54 per barrel in 2017, is forecast to average $60 per barrel in 2018 and $61 per barrel in 2019. EIA also expects India and China to be the largest contributors to growth in non-Organisation for Economic Co-operation and Development petroleum and other liquid fuels consumption in 2018 and 2019. According to the Economic Survey, $10 per barrel increase in the price of oil reduces growth by 0.2-0.3 percentage points.

Bond yields: Going by the current surge in bond yields, interest rate in India is unlikely to come down anytime soon. In fact, rates may increase further. Bond yields, which reflect the interest rate trajectory, have risen because of higher supply and fiscal slippage—the government raised fiscal deficit target for 2018-19 to 3.3% from 3%. Part of it was also because of fears of interest rate hike. But the market has not yet priced in the possibility of a rate hike. The bond market is not entirely convinced with the government’s plan of funding the deficit. “We think the revenue targets are on the optimistic side, particularly on recently-introduced GST tax revenue growth. We estimate a 20 bps upside risk to the fiscal deficit in FY19, unless economic activities formalize at a rapid pace over the coming year to generate the necessary buoyancy in revenues,” according to a Goldman Sachs report dated 1 February.