RBI maintains status quo on policy rate, cuts FY18 GVA growth to 6.6%, policy stance neutral

MUMBAI: The Reserve Bank of India (RBI) kept interest rates unchanged as expected on Wednesday, but warned of a spike in prices, fiscal profligacy and volatile global financial markets after the recent selloff, signalling that its ability to fuel growth may be limited. However, economic expansion is gathering momentum and there are signs of demand accelerating with a pickup in loan disbursals, it said.

RBI governor Urjit Patel also seemed to contribute to the current debate on the introduction of long-term capital gains tax on stocks in the February 1 Budget when explaining why investments were still subdued, although there appear to be signs of a pickup lately.

“Taxation on capital in India is from several sources and at the marginal rate it adds up,” he told reporters. “You have the corporate tax rate, you have the dividend distribution tax rate, for income above Rs 10 lakh you have the marginal tax rate at whatever bracket people are in, then there is the securities transaction tax and a capital gains tax — so there are five taxes on capital, which would have an impact on investment and savings decisions.”


Bond prices rose, reversing direction, as the RBI stuck to its neutral stance.

Tone Less Hawkish Than Expected
Also, the tone of the monetary policy statement was less hawkish than expected. Guv for Vigilance Around Inflation, although this may have been calibrated with the aim of calming a rattled market, experts said. RBI raised its inflation projection for the fourth quarter.

The Monetary Policy Committee (MPC) noted that the inflation outlook has been clouded by several factors, including house rent allowance (HRA) increases in some states, a global growth revival pushing up crude oil and commodity prices and higher minimum support prices (MSPs) for kharif crops. It also cited an increase in customs duty on some items, fiscal slippage and a winding down of the easy money policy globally.

“There is, therefore, need for vigilance around the evolving inflation scenario in the coming months,” RBI said.

RBI raised its inflation projection to 5.1% in the fourth quarter, including the impact of HRA payments, from 4.2-4.6% in the third quarter amid a surge in retail food prices. It had projected this at 4-4.5% in its August policy. The inflation forecast for the next fiscal year has been pegged at 5.1-5.6% in the first half and 4.5-4.6% in the second half, with risks tilted to the upside. The MPC is tasked with keeping consumer inflation at 4% with a band of two percentage points on either side.

“Over the last six weeks, the US 10-year yield has hardened by 40-50 basis points and that is a fair bit of movement,” Patel told reporters. “Over the last six months, domestic inflation has increased. In part of course this has been due to the hardening of crude prices. Because of the uptick in economic growth, there are now competing demands for financial capital, which puts upward pressure on all returns.” The repo rate, at which the central bank lends to banks, was held at 6% and the reverse repo rate, at which it pays banks for parking surplus funds, was maintained at 5.75%. All other rates also remained the same. The six-member MPC voted five-to-one in favour of the status quo on interest rates. RBI deputy governor Michael Patra voted for a rise in the policy rate by 25 basis points. A basis point is 0.01percentage point.

“The monetary policy was far less hawkish than expected given that RBI’s inflation target had been busted, fiscal limits breached and uncertainty on critical prices such as oil and local food prices has multiplied,” said Abheek Barua, economist at HDFC Bank. “Not only did the stance remain neutral, there were no indications of an imminent rate hike by the RBI. The governor chose not to discuss financial stability in detail despite the global financial market rout. This was done carefully so as to avoid another bout of panic in domestic markets.”

Monetary policy challenges include the inflationary threat due to rising food prices, higher government spending that could crowd out private investment and increased oil prices. The recent selloff in the global financial markets is the latest headache for policy makers.