Highlights of the RBI’s 5th bimonthly monetary policy review-
- Repo rate unchanged at 6 %. No change in CRR, SLR. Reverse Repo & Bank rate
- Inflation forecasts for Q4 (Jan-Mar quarter) raised. CPI inflation is expected to range between 4.3%.-4.7%, up from the earlier estimates of 4.2%-4.6%.
- Growth forecasts for the fiscal year 2016-17 retained at 6.7%
The RBI on Wednesday decided to keep the policy rates unchanged. 5 out of the 6 members of the RBI’s Monetary Policy Committee voted to keep the Repo rate at 6 %.
Read: Monetary Policy Committee Explained
Before discussing the monetary policy in details, know what Repo, CRR, SLR, Reverse Repo and Bank rate mean. Read: Monetary Policy tools explained
The reasons for maintaining status quo:
The RBI’s main objective is to keep CPI inflation below 4%. This is known as inflation targeting. The reasons for maintaining status quo are:
- CPI Inflation accelerated to 7-month high of 3.58% in October
- Core inflation (4.5%) remains sticky, that is, resistant to change.
(Read about what is CPI Inflation, WPI Inflation, Core inflation & Headline inflation)
- There is a risk of inflation rising further due to rising global commodity rises, especially crude oil prices.
- Stronger growth in the July-Sept quarter (6.3%) obviated the need for a rate cut to stimulate investment and consumption.
- Central Banks around the world are likely to tighten Monetary Policy in the coming months.
The case for a rate cut
All the analysts are not in agreement with the RBI’s decision. They were calling for a rate cut due to the following reasons:
- Though GDP growth rate has picked up in the recent quarter, it is still below its potential. A Mint article argues that GDP is 1 % below its potential. Given the fact that the Government had already exhausted 96 % of its fiscal deficit target until October, RBI should have cut rates to boost consumption and private investment.
- Bond yields have also gone up: To prevent the rupee from appreciating, the RBI has been buying dollars and selling Rupees in the money market. This has led to an increase in liquidity in the money market. The RBI had to resort to bond sales (Open Market Operations) to mop up the excess liquidity. Bond sales have pushed prices down and increased bond yields. With no rate cuts, the RBI will have to depend on open market operations to control liquidity despite hardening yields. In nutshell, a rate cut would have prevented the rupee from appreciating.
- If we look at past data, RBI has consistently overestimated inflation.
- Oil prices affect inflation more than higher interest rates.
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