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Dec 06, 2017 04:04 PM IST | Source: CNBC-TV18

Top 5 reasons why RBI decided to keep rates on hold for now

Banking stocks dragged the S&P BSE Sensex by over 200 points while the Nifty50 closed below 10,050 levels. The RBI decided to opt for a cautious stance which leaves little room for the central bank to cut interest rates further, suggest experts.

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Keeping one eye on inflation and rising global headwinds, the Reserve Bank of India (RBI) on expected lines decided to keep rates on hold for now in its fifth Bi-monthly monetary policy statement released on Wednesday.

Banking stocks dragged the S&P BSE Sensex by over 200 points while the Nifty50 closed below 10,050 levels. The RBI decided to opt for a cautious stance which leaves little room for the central bank to cut interest rates further, suggest experts.

RBI has estimated inflation to be in the range of 4.3-4.7 percent for Q3 and Q4 respectively. But, a rate cut would have helped the economy and boost growth in Asia’s third-largest economy.

“RBI’s policy was in line with expectations, maintaining a word of caution on the upside risks emanating from high commodity prices, global financial instability, HRA related increases, rising input costs, and fiscal slippages,” Upasna Bhardwaj, Sr. Economist, Kotak Mahindra Bank told Moneycontrol.

“RBI’s 2H inflation has been revised marginally higher by 10 bps to 4.3-4.7 percent even as they retained the GVA forecast of 6.7 percent as against our expectation of 6.5 percent,” she said.

Bhardwaj further added that given that MPC members are fixated with anchoring 4 percent inflation target and the upside risks emanating from higher oil prices, higher rural real wages, sticky core inflation and mean reversion of food prices, we find limited room for any further monetary accommodation this year.

We have collated a list of top five reasons why RBI decided to maintain a status-quo stance on rates:

Rise in inflation:

The MPC notes that inflation expectations, i.e., food and fuel inflation, edged up in November. Inflation expectations of households surveyed by the Reserve Bank have already firmed up and any increase in food and fuel prices may further harden these expectations.

On the whole, inflation is estimated in the range 4.3-4.7 percent in Q3 and Q4 of this year, including the HRA effect of up to 35 basis points, with risks evenly balanced, said the RBI statement.

"As was widely expected RBI kept key rates unchanged and continued to sound caution on inflation, raising their forecast marginally. Their stance remains expectedly neutral," Bekxy Kuriakose, Head – Fixed Income, Principal Pnb Asset Management Company said.

"They seem to sound positive on growth highlighting recent increased issuance and availability of equity capital to corporates and SMEs which should get spent on new projects," said Kuriakose.

Global Financial Instability:

The global financial instability on account of the pace of/uncertainty over monetary policy normalisation in advanced economies (AEs) and fiscal expansion in the US carry risks for inflation. The US Federal Reserve is scheduled to hold its 2-day policy meeting starting December 13-14.

US growth remained largely resilient to hurricanes and grew at the highest pace in the past three years in Q3 of 2017, with positive contributions from private consumption, investment activity, and net exports.

The unemployment rate fell to 4.1 percent in October, the lowest in the last 17 years. In the Euro area, economic activity expanded, underpinned by accommodative monetary policy and strong job gains. The Japanese economy also continued to grow in Q3, largely supported by external demand, which helped compensate for the slowing of domestic consumption.

Global financial markets have remained buoyant, reflecting the improving economic outlook and the gradual normalisation of monetary policy by the US Fed.

High Commodity Prices:

Crude oil prices touched a two-and-a-half-year high in early November on account of the Organisation of the Petroleum Exporting Countries’ (OPEC) efforts to rebalance the market. Weak non-oil commodity prices and subdued wage dynamics have kept inflation contained in many AEs, while the inflation scenario remains diverse in major EMEs.

The recent rise in international crude oil prices may sustain, especially on account of the OPEC’s decision to maintain production cuts through next year. In such a scenario, any adverse supply shock due to geo-political developments could push up prices even further, said the RBI statement.

HRA Increase:

The impact of house rent allowance (HRA) by the Central Government is expected to peak in December. The staggering impact of HRA increases by various state governments may push up housing inflation further in 2018, with attendant second order effects.

Fiscal Slippages:

Implementation of farm loan waivers by select states, partial rollback of excise duty and VAT in the case of petroleum products, and a decrease in revenue on account of reduction in GST rates for several goods and services may result in fiscal slippage with attendant implications for inflation.
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