RBI maintains an Anti-inflation stance

BY GAURAV KULSHRESHTHA | 06 APR, 2017

The first bi-monthly Monetary Policy statement for the year 2017-18 was released today by Reserve Bank of India. Following were the highlights.

  • The MPC decided to keep the policy rate unchanged (Repo Rate-6.25%) while persevering with the neutral stance (in line with expectations). All 6 members voted in favor of the decision.
  • But surprised markets by deciding to narrow the LAF corridor around the policy repo rate to +/-25bps from +/- 50bps. Consequently, the reverse repo rate under the liquidity adjustment facility (LAF) would be 25 bps lower than the policy repo rate (Rev Repo Rate-6.00%) and the marginal standing facility (MSF) rate would be 25 bps higher than the policy repo rate (MSF Rate-6.50%).
  • Also, RBI is looking forward to establishing of a standing deposit facility (SDF) for which government will have to move an amendment to RBI Act. This will allow large scale absorption of liquidity in an uncollateralized fashion and will further strengthen RBI’s tool kit for liquidity management.

RBI’s Assessment & Outlook

On the domestic front, growth as measured by Gross Value Added (GVA) is seen rising in FY18 to 7.4% from 6.7% in FY2017, while inflation is expected to stay around 4.5%-5.0% mark.

While RBI acknowledged that inflation has undershot their expectation during the March quarter, nonetheless its path through 2017-18 appears uneven and challenged by upside risks and unfavorable base effects towards the second half of the year. Upside risks to inflation may emanate from a rising probability of El-Nino, implementation of the allowances recommended by the 7th CPC, closing output gap, one-off effects of GST, global reflation & increasing commodity prices along with geo-political risk induced financial market volatility. Though they also acknowledged the softening of crude prices

RBI also noted that the general government deficit remained high by international comparison and poses yet another risk to inflation, which may get exacerbated by farm loan waivers.

In RBIs assessment, while banks have reduced lending rates, further scope for a more complete transmission of policy impulses remain, including for small savings/administered rates.

RBI expects the liquidity surplus to gradually narrow over the next few quarters and It will continue to use its existing bouquet of instruments (LAF, term repos, cash management bills, MSS and if required OMOs) to manage the excess liquidity in the near-term.

Citi Economist Views

Citi economist believe that the RBI’s decision to narrow the LAF corridor (consequently increasing reverse repo rate by 25bps) may be seen as its determination to not let the marginal pricing of interbank funding slip too far below the repo rate and may not be confused with rate hike. Unlike their expectation that RBI may soften the tone on account of INR appreciation, moderation in commodity prices and lesser than expected market impact of US policies, the RBI has stuck to the strong anti-inflationary stance.

Consequently, Citi economists expect an extended pause for the near future. The narrowing of the LAF corridor is likely to push up yields for some T-bills, but the average overnight rate may rise only by a few basis points. They believe that this is a step towards a single policy rate regime where MSF is 25 bps above repo and SDF is 25 bps below repo. This may allay fears of an imminent CRR hike. They believe that the bond yields may rise slightly and the OIS curve may steepen. However they do not foresee the yields breaking back above the recent highs. The risk to this view being - significant rally in oil prices or a material jump in US yields.


DAILY NEWSLETTER


VIDEOS

Can the Trump Effect Continue to Lift Markets Citi Wealth Insights


Europe Politics Present an Opportunity Citi Wealth Insights


Chinas Growth Surprise This Year Citi Wealth Insights