1. Monetary policy review: Four things RBI will consider to hold or cut interest rates

Monetary policy review: Four things RBI will consider to hold or cut interest rates

Slowing services sector activity, government's fiscal consolidation stance may help RBI to ease policy rates, but rising inflation, crude oil prices may weigh.

By: | Published: February 6, 2017 12:21 PM
Indian monetary policy, RBI Act, primary monetary policy objective, MPC, FCNR deposits Assocham has demanded a 75 basis points cut in the repo rate to 5.5%, another body Ficci believes the RBI will hold the rates steady in this review before cutting those later in the year.

The acceleration in retail inflation may make it difficult for the Reserve Bank of India to cut the key policy rates for providing the required impetus to the credit offtake. While on the other hand, the slowdown in the country’s services activity, the government’s fiscal prudence and its intent towards fiscal consolidation may give the central bank some room to lower the benchmark rates.

Rising crude oil prices, hint of increasing interest rates in the US and excess liquidity with banks may also weigh upon the Monetary Policy Committee – the six-member body which will decide whether to cut or hold the rates.

While the industry body Assocham has demanded a 75 basis points cut in the repo rate to 5.5%, another body Ficci believes the RBI will hold the rates steady in this review before cutting those later in the year.

Here are the factors the monetary policy committee will consider:

Growth: India is pegged to continue to be the fastest growing major economy, ahead of China. Earlier last week, Economic Affairs Secretary Shaktikanta Das said India would grow at over 7% in the next financial year 2017-18, as the impact of demonetisation on the economy would be short-lived, not spilling to the next year. Further, the Economic Survey for the year said that the demonetisation could be beneficial in the long run if formalisation increases and corruption falls. The survey projects India’s GDP for the fiscal 2017-18 growing at 6.75%-7.5%. However, the PMI (purchasing managers’ index data released earlier) showed that India’s services sector activity slowed for the third month in a row in January. “India’s pivotal service sector remained in contraction territory in the opening month of 2017, with both new business and activity falling for the third straight month,” the survey compiler IHS Markit said, adding, “A rebound in the near term is likely as rates of reduction softened and business confidence improved on the back of hopes that market conditions will soon normalise.”

Inflation: Retail inflation as measured by the CPI (consumer price index) accelerated to 5.61% in December, rising for the fifth straight month, led by rise in vegetable and cereal prices, limiting the headroom for the RBI to cut rates. However, the wholesale inflation (WPI) fell in December but the fall at 0.73% was the slowest in last one year as food prices shot up, indicating return of inflationary pressures.

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Crude oil prices: Crude oil prices have risen since November when the OPEC nations agreed to cut output to support the international prices. Brent crude rose to $56.91 per barrel on Monday on fears that the new US sanctions against Iran could be extended, affecting supplies further. India meets 80% of its energy requirements through imports, and rising crude oil prices may disturb the government maths, which will have to shell out more money, pressurising the fiscal deficit.

Fiscal deficit: Earlier last week, Finance Minister Arun Jaitley proposed to relax the fiscal deficit limit for his government to 3.2% of GDP in order to enable higher public spending to boost investments and consumption. The relaxation from the earlier prescribed limit of 3% was not as steep as some had expected on account of a much-needed spending stimulus to the economy, providing RBI with some headroom to cut rates. “Despite mounting expectations of fiscal largesse through the budget, the government maintained its fiscal stance towards consolidation. The expenditure mix as well as the stance bodes well for long-term macroeconomic stability,” Kotak Economic Research said in a note, adding, “This strengthens our call for a 25 bps rate cut in the next RBI policy on February 8.”

 

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