MUMBAI: The Reserve Bank of India (RBI) kept the repo rate—its key lending rate—unchanged at 6.25 percent, forecast robust a 7.4 growth in 2017-18 aided by waning effects of demonetisation, although inflation risks remain in the medium term.
The RBI hinted at a looming inflation threat over the next 6-12 months, obliquely leaving the door partially open for an interest rate hike in 2017-18.
For 2017-18, inflation is projected to average 4.5 per cent in the first half and 5 per cent in the second half.
“Underlying inflation pressures persist, especially in prices of services. Input cost pressures are gradually bringing back pricing power to enterprises as demand conditions improve,” the central bank said flagging weak monsoon, expected rise in Government employees’ allowances and goods and services tax (GST) as the primary factors that could knock up prices in the short-term.
The status quo on rates, however, was accompanied by a string of regulatory changes including raising the reverse repo by 25 basis points to 6 percent, allowing banks to investment in real estate investment trusts (REITs), raising the minimum fund requirements of asset reconstruction companies (ARCs), allowing collateral substitution under repo that will give banks more funds to lend, and proposing the introduction of standing deposit facility (SDF)—another window for banks to borrow.
The six member monetary policy committee (MPC), headed by RBI Governor Urjit Patel, also reduced the liquidity corridor – the difference between the repo and reverse repo rates or the liquidity adjustment facility (LAF)—to 25 basis points with immediate effect.
Reverse repo is the rate at which RBI borrows from banks to absorb or release cash from and into the system.
At higher reverse repo, the central bank would suck cash from the system to stymie demand and cool prices. It will also encourage banks to park excess funds with the RBI that will fetch higher returns.
Banks are awash with funds as millions have deposited outlawed old Rs 500 and Rs 1000 notes between November 8 and December 30, 2016.
The overnight call-money rates—the rate at which banks lend to each other to address daily liquidity shortages—normally remains within the LAF.
Last year, RBI announced its intent to progressively reduce the LAF from 100 basis points to 25 basis points, based on an expert panel’s recommendations.
Likewise, the marginal standing facility (MSF) or the rate at which banks borrow from the RBI during periods of acute liquidity shortage, will stand reduced to 6.5 percent.
When banks are extremely short of funds, they are willing to pay a higher interest rate to borrow extra money from the RBI even at a much higher rate.
It will now stand at 25 basis points above the repo rate.
“In either extremely tight liquidity conditions or in situations of persistent excess liquidity, when most market participants are on one side of the market for overnight liquidity, a narrower corridor can contribute to finer alignment of the operating target with the policy rate,” the RBI said in a statement on `Developmental and Regulatory Policies’.
Raises outlook for GDP growth
The RBI has however hiked its outlook for GDP growth to 7.4 per cent in this fiscal from 6.7 per cent last year. Inflation is expected to average around 4.5 per cent in the first half and 5 per cent in the second half.