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April 05, 2018

Standing pat after de facto tightening

  • The Reserve Bank of India’s (RBI), Monetary Policy Committee (MPC) kept policy rates on hold at its review meeting on Thursday. It maintained the repo rate at 6%, the reverse repo at 5.75%, and the marginal standing facility rate at 6.25%. Five of the six committee members supported the decision, with one voting for a 25 basis points (bps) hike.
  • The decision to hold is based on uncertainty on the inflation trajectory, mainly (i) impact of minimum support price (MSP) announcement on food prices, (ii) staggered impact of house rent allowance (HRA) revisions by state governments and possible second round pressures of HRA revisions on overall inflation, (iii) impact of possible fiscal slippages, and (iv) uncertainty on the distribution of monsoon. All this will need monitoring in the coming months. Therefore, any rate action needs to be taken with due caution and after weighing the data.
  • The MPC maintained its neutral monetary policy stance with a focus on maintaining medium-term inflation at 4%. For fiscal 2019, the MPC revised down its inflation outlook supported by recent sharp moderation in food prices and the statistical downside that will accrue in mid-2018 as the impact of the Seventh Pay Commission payments fades. The inflation forecast for fiscal 2019 is revised down to ~4.7% average, from ~5% estimated earlier. Yet, given upside pressures, the MPC will stay vigilant on the evolving inflation scenario. The forecast for gross domestic product (GDP) has been kept unchanged at 7.4% for fiscal 2019.

Our view


The status-quo was on expected lines. CRISIL expects the repo rate to remain unchanged over the next six months unless upside risks to the MPC’s inflation forecast materialise.


Even with the RBI’s neutral stance, there was a de facto interest rate tightening in the banking system. The risk-free rate in the economy – the 10-year government security yield – jumped 40 basis points (bps) this year so far on fears of fiscal slippage. But this has corrected now due to a trimmer borrowing program announced by the government for first half of fiscal 2019 and today’s MPC decision to keep the rates on hold. Meanwhile, banks also had started raising their deposit and loan rates after a nearly four-year rate easing cycle.


Inflationary pressures need watching: Between the February MPC meet and now, some inflationary pressures have reared up. Global crude oil prices have continued to rise since then and are now nearly 27% higher on-year. In fiscal 2019, CRISIL expects prices to rise another 13%. Similarly, metal prices are also firmer. Given improving domestic demand conditions, manufacturers are likely to pass on higher input prices to consumers. Similarly, there could also be pressure on food inflation if elements of the MSP announcement, such as setting it at 1.5 times the cost of production, extension of MSP to all kharif crops, and assuring at least MSP is paid to all farmers, together with rise in import duties are implemented. All this will need monitoring in the coming months.


De facto tightening of interest rates: Fiscal pressures drove up the yield on the 10-year G-sec to 7.62% by March (average), from 7.18% in December. G-Sec yields have however, softened now. Similarly, banks, too, had started raising their lending rates led by two factors (i) expected drying up of surplus liquidity from the banking system as the RBI aims to go back to maintaining neutral conditions, and (ii) return of demand for bank credit from corporates as interest rates in the bond market firm up. About 7-8 banks have raised their marginal cost of lending rate (MCLR) by about 10 to 20 bps in 2018 so far, suggesting that despite the repo rate staying unchanged, banks appear to be pricing in an expectation of turn in the interest rate cycle. With today’s non-move, the upside risks to lending rates has reduced.