RBI monetary policy: Why apex bank kept repo rate unchanged

High economic growth despite the Modi government's cash ban has surprised economists around the world and eased RBI's worries on the growth front. Hence, it did not ideally cut repo rate to stimulate growth.

The Reserve Bank of India kept repo rate unchanged and hiked reverse repo by 25 basis points to 6%. The bank announced its first bi-monthly monetary policy statement for 2017-18 today. The apex bank in the past three policy meets has surprised all with its decisions.

In October, the monetary policy committee (MPC) unexpectedly cut rates and then it held them in December when markets were betting on an easing move.

In February, the committee again surprised by holding rates and switching to a "neutral" stance from "accommodative" - a move that made bond yields spike. All decisions were taken by a unanimous 6-0 vote, adding to the surprise.

In today's policy too, the bank maintained its "neutral" stance which it adopted on February 8, 2017.

A neutral stance means the bank is neither willing to step up money supply in the economy nor it intends to cut the same to curb growth.

An accommodative stance signals that the bank is willing to ease interest rates to raise money supply in the economy to ward of slowdown fears.

Here's why the RBI took a neutral approach and maintained status quo in today's policy meet.

Inflation concerns

Retail or consumer price inflation rose to 3.65 per cent in February against 3.1 per cent in January.

Even though prices rose, they are well under the comfort zone of the RBI which "set a target of consumer price index or CPI inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of plus or minus 2 per cent, while supporting growth."

Headline or wholesale inflation also rose to 6.55 per cent in February compared with 5.25 per cent in the previous month but the bank likely decided on the policy stance, considering the CPI only.

It said: "Since the February bi-monthly monetary policy statement, inflation has been quiescent. Headline CPI inflation is set to undershoot the target of 5 per cent for Q4 of 2016-17 in view of the sub-4 per cent readings for January and February. For 2017-18, inflation is projected to average 4.5 per cent in the first half of the year and 5 per cent in the second half."

Robust economic growth

Gross domestic product (GDP) growth slowed to an annual 7 per cent in October-December from 7.4 per cent in the previous quarter. Analysts polled by Reuters had expected a 6.4 percent growth rate. India's growth was higher than China's 6.8 percent for the last three months of 2016. High economic growth despite the Modi government's cash ban has surprised economists around the world and eased RBI's worries on the growth front.

"Several favourable domestic factors are expected to drive this acceleration. First, the pace of remonetisation will continue to trigger a rebound in discretionary consumer spending. Activity in cash-intensive retail trade, hotels and restaurants, transportation and unorganised segments has largely been restored. Second, significant improvement in transmission of past policy rate reductions into banks' lending rates post demonetisation should help encourage both consumption and investment demand of healthy corporations. Third, various proposals in the Union Budget should stimulate capital expenditure, rural demand, and social and physical infrastructure all of which would invigorate economic activity. Fourth, the imminent materialisation of structural reforms in the form of the roll-out of the GST, the institution of the Insolvency and Bankruptcy Code, and the abolition of the Foreign Investment Promotion Board will boost investor confidence and bring in efficiency gains. Fifth, the upsurge in initial public offerings in the primary capital market augurs well for investment and growth, " the RBI statement said.

Hence, it did not ideally cut repo rate to stimulate growth.

NPA resolution mechanism in sight

In the February monetary policy, RBI governor Urjit Patel emphasised that that banks still have scope to cut lending rates. He reasoned that while the RBI had cut the repo rate cumulatively by 175 basis points since January 2015, banks' weighted average lending rate had come down by only about 80-95 basis points, at the most.

It has been noted that banks have not been able to transmit the effect of RBI rate cut wholly partly due to their rising NPAs since the move will hit their margins which are already under pressure due to bad loans.

As on September 30, 2016 gross NPAs of public sector banks rose to Rs 6,30,323 crore as against Rs 5,50,346 crore by June end. This represents an increase of Rs 79,977 crore on quarter on quarter basis.

But last month Finance Minister Arun Jaitley said his ministry and the Reserve Bank of India have taken a major policy decision on dealing with non-performing assets (NPAs) of banks.

The resolution being worked out with the RBI will put enough pressure on borrowers to settle dues, Jaitley added.

Small savings rate cut

The government on March 31, 2017 lowered the interest rate by 0.1 per cent on Public Provident Fund (PPF) and small savings deposits. The new rate would be effective from April 1. Since April last year, interest rates of all small saving schemes have been recalibrated on a quarterly basis.

It's a move which is aimed to make interest rates market driven and linked to the returns of government securities. It will leave more money with the banks and add to their liquidity, thus reducing possibilities of a rate hike.

Brightening Economic parameters

The bank admitted that economic activity has been on an upward trajectory and a rate cut would not have been an ideal option, injecting liquidity into the system.

"Industrial output, measured by the index of industrial production (IIP), recovered in January from a contraction in the previous month, helped by a broad-based turnaround in manufacturing as well as mining and quarrying. Capital goods production improved appreciably, although this largely reflected the waning of unfavourable base effects. Consumer non-durables continued, however, to contract for the second successive month in spite of supportive base effects. Thus, investment and rural consumption demand remain muted. The manufacturing purchasing managers' index (PMI) remained in expansion mode in February and rose to a five-month high in March on the back of growth of new orders and output. The future output index also rose strongly on forecasts of pick-up in demand and the launch of new product lines. The 77th round of the Reserve Bank's industrial outlook survey indicates that overall business sentiment is expected to improve in Q1 of 2017-18 on the back of a sharp pick up in both domestic and external demand. Coincident indicators such as exports and non-oil non-gold imports are indicative of a brighter outlook for industry, although the sizable under-utilisation of capacity in several industries could operate as a drag on investment, " the bank statement said.