Four reasons why RBI is likely to keep repo rate unchanged

The central bank has actually signalled that there is not much scope for reducing the interest rates. Clearly, the monetary policy committee must have taken this decision after much deliberation and thought.

The Reserve Bank of India (RBI) is expected to keep the policy rate (repo rate) unchanged at 6.25 per cent in its first bi-monthly monetary policy review on Thursday. Here are four reasons why the RBI will opt for status quo;

1) Shift in policy stance from accomodative to neutral

This big surprise came in the last policy in January this year, when the RBI suddenly announced a shift in policy stance from accomodative to neutral. The central bank has actually signalled that there is not much scope for reducing the interest rates. Clearly, the monetary policy committee must have taken this decision after much deliberation and thought.

2) Inflation on an upswing

Inflationary pressure is also building up in the economy. The consumer price index (CPI) or the retail inflation rose to 3.65 per cent in February compared with 3.1 per cent in January. The main culprit is food prices which are on the rise. The wholesale price index (WPI), too, is rising, closing at 6.55 per cent in February compared with 5.25 per cent in the previous month. A higher WPI generally shows up in retail inflation or CPI with a lag effect.

3) Surplus liquidity in the system

There is a surplus liquidity in the system post demonetisation. Banks, flush with funds-especially cheaper deposits-are also doing retail lending aggressively. The surplus liquidity in the system has all the potential to fuel inflationary pressure.

4) Fed rate hike and interest rate arbitrage

The US, which has near zero interest rates post 2008, is now back to a normal monetary policy regime. Last month, the US Federal Reserve hiked the short term interest rates by 25 basis points. The direction very clearly is towards hardening of interest rates.This rise in US rates makes a case for higher interest rates to keep the arbitrage game going as US funds would flow into India.

Theoretically, if Indian rates go down further as US rates inch up, there is likelihood of funds flowing out of the country, thereby putting pressure on the rupee and later bringing in imported inflation.