The Reserve Bank of India (RBI) on Tuesday cut its key lending—the repo rate—by 25 basis points to 6.25 percent, as a newly set up panel felt that inflation levels were low enough to reduce loan rates.
The decision of the monetary policy committee (MPC), headed by new RBI governor Urjit Patel, will likely cheer business leaders and households as cheaper loans will aid investment and spending.
The six member panel, which brainstormed over two days, unanimously agreed that inflation was unlikely to gallop past the tolerance threshold of 6 percent in the near future.
The MPC expects retail inflation rates to hover around 5 percent by March 2017, the RBI said in a statement, which is well within the comfort zone.
A lower repo rate—the rate at which banks borrow from RBI--would mean households may expect cheaper bank loans to buy houses and goods such as cars, which peak during the festival shopping season in October and November.
The BSE Sensex rose 85 points to 28,328 mirroring the stock markets’ heightened expectations about lower rates.
Since January 2015, the RBI has cut the repo rate six times.
India’s retail inflation has touched a five-month low of 5.05 percent in August, triggering hopes of a rate cut.
“The MPC expects that the strong improvement in sowing, along with supply management measures, will improve the food inflation outlook,” the RBI said in a statement.
The drop in overall inflation rates has been primarily aided by continuous drop inflation in food inflation.
The committee credited the drop in food inflation to recent efforts by the government to keep price growth in check including measures to tame prices of pulses, a common source of protein for most Indians.
“Food inflation holds the key to future inflation outcomes,” the RBI statement said.
“The government has announced several measures to cool food inflation pressures, especially with regard to pulses. These measures should help in moderating the momentum of food inflation in the months ahead,” it said.
India’s economy grew 7.1% during April to June, the slowest in 6 quarters, but the RBI and the MPC expect a revival in the coming months boosted by good rains, a pay bonanza for government employees and festive season buying.
The RBI retained its earlier growth projection of 7.6 percent for 2016-17.
“The momentum of growth is expected to quicken with a normal monsoon raising agricultural growth and rural demand, as well as by the stimulus to the urban consumption spending from the pay commission’s award,” the RBI statement said.
Besides, banks appear to be awash with funds and well equipped to deal with rise in loan growth demand to aid new investments.
“The accommodative stance of monetary policy and comfortable liquidity conditions should support a revival of credit to the productive sectors,” the statement said.
The spurt in demand could, however, potential push inflation.
“The Committee took note of potential cost push pressures that may emerge, including the 7th pay commission award on house rent allowances, and the increase in minimum wages with possible spillovers through minimum support prices. The fuller play of these factors will need vigilance to prevent a generalised cost spiral from taking root,” it said.
The RBI and the government have set a retail inflation target of 4 per cent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 per cent.
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