RBI monetary policy 2017: Hawkish turn surprises markets; loans may not turn cheaper

By: | Published: February 9, 2017 6:29 AM

The Reserve Bank of India’s (RBI) somewhat surprising change in monetary stance signals a halt to the rate-cutting cycle and suggests loans may not get cheaper in the near term.

The central bank said on Wednesday that a shift to a neutral stance and a hold on rates were called for to assess how the transitory effects of demonetisation played out on the output gap. (PTI)The central bank said on Wednesday that a shift to a neutral stance and a hold on rates were called for to assess how the transitory effects of demonetisation played out on the output gap. (PTI)

The Reserve Bank of India’s (RBI) somewhat surprising change in monetary stance signals a halt to the rate-cutting cycle and suggests loans may not get cheaper in the near term.

The central bank said on Wednesday that a shift to a neutral stance and a hold on rates were called for to assess how the transitory effects of demonetisation played out on the output gap.

Growth as measured by gross value addition, the RBI forecasts, will come in at 7.4% for 2017-18, a good 50 basis points lower than its earlier projection of 7.9%.

With the RBI committed to bringing headline inflation closer to 4%, the bond market went into a tizzy; the yield on the benchmark jumped a sharp 31 basis points to close at 6.739%.

Traders expect the yield to rule in the range of 6.65% to 6.85%; post-demonetisation the yield had dropped to 6.19%, a seven-year low with banks seeing a deluge of deposits.

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While bankers were non-committal on the trajectory of lending rates, some lenders conceded loan rates might not fall further. While banks are flush with funds, they have lowered only their marginal cost of funds rate (MCLR) and not the base rate, which continues to be the benchmark rate for the majority of borrowers. Patel pointed out on Wednesday that while the policy rate had come off by 175 basis points, the weighted average lending rate had been reduced by 80-90 basis points.

He observed that if transmission — of policy rates into loan rates — was to be facilitated, the government needed to recapitalise lenders, resolve the non-performing assets (NPA) problem and tweak interest rates on small savings schemes to bring them in sync with market rates.

The central bank believes rising prices of crude oil and other commodities pose upside risks to inflation. It was also possible, demonetisation might result in supply side constraints thereby pushing up prices. Moreover, the global food index too had gone up. “There’s enough global uncertainty to go around,” RBI governor Urjit Patel said at a press conference. The RBI expects consumer inflation at between 4% and 4.5% in the first half of FY18 and 4.5% and 5.0% in the second half FY18.

Sonal Varma, economist at Nomura, said she expected inflation to average above its target — at around 5% in FY18. “Thus we expect policy rates to remain unchanged at 6.25% throughout 2017 against our earlier expectations of a 6% terminal rate,” Varma wrote on Wednesday.

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