India’s central bank left its benchmark repo rate at 6.0 percent, as widely expected, but surprised many analysts by maintaining a neutral policy stance despite raising its forecast for inflation and saying the risks were to the upside.
The Reserve Bank of India (RBI), which has maintained its rate since cutting it by 25 basis points in August 2017, said the outlook for inflation was clouded by several uncertainties on the upside that called for “vigilance,” but on the other side there were also several mitigating factors.
Illustrating this uncertain outlook for inflation, the RBI’s monetary policy committee was split in its decision, with five members voting to maintain rates while one member, Michael Debabrata Patra, voting for a hike of 25 basis points.
At its previous meeting in December, five members had also voted to maintain the rate, including Patra, while one member had voted to reduce the rate.
The RBI’s policy decision comes only days after India’s government published its budget for the 2018/19 financial year, which begins April 1, which boosts spending by 13.2 percent on healthcare and infrastructure, especially in rural areas.
The budget targets a fiscal deficit of 3.3 percent of Gross Domestic Product in 2018/19, up from a previous target of 3.0 percent and an estimated 3.5 percent deficit this year.
The RBI welcomed the budget’s focus on infrastructure and rural sectors as this would boost incomes, investment and thus demand and economic activity.
“On the downside, the deterioration in public finances risks crowding out of private financing and investment,” the RBI said, echoing concerns in financial markets where India’s 10-year bond yield has risen steadily since September last year to 7.57 percent today.
In his budget, Finance Minister Jaitley forecast 2018/19 growth of 7.2 percent, a forecast the RBI reiterated, adding growth in the first half of the year would be 7.3-7.4 percent and then 7.1-7.2 percent in the second half, with risks evenly balanced.
Growth in the current 2017/18 year, which ends March 30, growth is projected at 6.6 percent, slightly below earlier forecasts of 6.7 percent, as the economy recovers after being hit by the government’s surprise decision in November 2016 to ban 500 and 1,000 rupee notes – around 86 percent of currency in circulation.
While the aim of the note ban was to root out corruption and tax evasion, it dented consumer demand and cash-sensitive sectors, such as retail, hotels, restaurants and transportation.
Growth in the 2016/17 financial year slowed to 7.1 percent from 8.2 percent in the previous year.
India’s inflation rate rose to a higher-than-expected 5.21 percent in December, the highest since July 2016, and above November’s 4.88 percent, when inflation topped the RBI’s target of 4.0 percent.
Citing a range of uncertainties, the RBI raised its forecast for inflation in the current quarter to 5.1 percent from the previous forecast of 4.3 to 4.7 percent.
For 2018/19 inflation is estimated in a range of 5.1-5.6 percent in the first half of the year, and 4.5-4.6 percent in the second half, with risks tilted to the upside.
The RBI has a tolerance range of plus/minus 2 percentage points around the 4.0 percent midpoint.
The Reserve Bank of India issued the following statement:
- keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.0 per cent.