Inflation risks force RBI to keep rates on hold

Rajan warns of potential dollar shortage in Sept but prepared to provide liquidity

The Reserve Bank of India (RBI) on Tuesday kept its policy rates unchanged owing to the recent upsurge in prices, which, if not checked, would force the central bank to keep rates on hold despite its wish to cut further.

As a result, the policy repurchase rate remained 6.5 per cent. The cash reserve ratio, the share of money banks need to keep with the central bank, too, was unchanged at four per cent of the deposit base.

"Given the uncertainties, RBI will stay on hold, but the stance of monetary policy remains accommodative. RBI will monitor macroeconomic and financial developments for any further scope for policy action," went RBI's statement.

 
"What we are really saying is that we haven't shifted stance to either a neutral or tightening stance. We are still accommodative. That means we are looking for room to ease," RBI Governor Raghuram Rajan said in a post policy press conference.

Rajan also warned about a potential dollar shortage in the market in September, when about $20 billion worth of foreign currency non-resident (FCNR-B) deposits mature. However, he said, the central bank was prepared to provide liquidity even as counterparties with which it has entered into dollar purchase agreements could face difficulties in supplying the greenback.

Rajan was evasive on his reappointment, which has of late induced volatility in the currency market.

In its second bi-monthly monetary policy statement for 2016-17, RBI said the upsurge in inflation in April, led by food and commodity prices, was "sharper-than-anticipated." The rise in prices could be offset only by a strong monsoon, continued astute food management and steady expansion in supply capacity, especially in services.

Wholesale price index-based inflation rose 0.34 per cent in April, compared with -0.85 per cent in March. The retail inflation number, tracked by the central bank for policy purposes, rose to 5.39 per cent in April, from 4.83 per cent in March.

Indeed, the April inflation "surprise" makes the "future trajectory of inflation somewhat more uncertain," the policy said.

Besides, how the Seventh Pay Commission's recommendations are implemented will also alter the inflation math. Households and corporate firms are expecting prices to rise and, therefore, RBI kept the inflation forecast unchanged at five per cent with an upside bias. The central bank will wait for more data to get clarity on inflation, it said.

To force banks to pass on the cumulative 150 basis points rate cut, RBI said it will revisit the calculation of marginal cost-based lending rate (MCLR), which became effective from Banks so far have passed on about 75-90 basis points of the cut. They have effectively dodged the MCLR methodology by playing on the spread that they are allowed to add up to their cost. The RBI governor was also concerned about this practice and said the central bank needs to take a relook. Transmission "still remains work in progress," Rajan said.

Retaining its growth forecast for 2016-17 unchanged at 7.6 per cent, RBI squarely put the ball in banks' court saying "more monetary transmission to support the revival of growth continues to be critical."

Deutsche Bank said in a report that RBI's policy focus is now shifting to achieve faster and greater monetary transmission. "The view seems to be that the gap between the policy rate and bank base rates need to narrow significantly; as and when that takes place, monetary conditions would ease considerably," Deutsche said in the report.

"The government's reform measures on small savings rates combined with the RBI's refinements in the liquidity management framework should help the transmission of past policy rate reductions into lending rates of banks," according to the policy statement. It added that timely capital infusion in banks will aid credit flow.

Remaining non-committal on faster reduction of the lending rate, State Bank of India Chairman Arundhati Bhattacharya emphasised that timely capital infusion was crucial. ICICI Bank's Managing Director and Chief Executive Officer Chanda Kocchar said improvement in liquidity will support banks' ability to cut rates.

Rajan said the central bank was committed to infuse as much liquidity as needed to bring the system liquidity closer to neutral from deficit mode. "We will always provide what the market requires. We are committed to that," Rajan said.

In a stern warning to counterparties who have expressed concerns about their ability to supply dollars to RBI in September, Rajan said the central bank would not bail them out. "We don't want to create moral hazard in the system," he said.

RBI is also working with the government on facilitating the bank balance sheet clean-up process and is consulting with the capital market regulator Securities and Exchange Board of India on how to revive projects and allow incentives for promoters to earn their way out of difficulty. "However, there is no intent to go back to the days of forbearance or reverse the move towards transparent bank balance sheets," the RBI governor said.

According to Rajan, the agenda set by him when he became governor in September 2013 has mostly been delivered. But he said he still has some unfinished business, like bringing down inflation, cleaning up bank balance sheets and initiating reforms for the long term. Development of the corporate bond market, financial inclusion and reforms in loans to small firms too are part of Rajan's unfinished agenda, he said.

On reappointment, Rajan points to statements of PM & FM

When asked about his reappointment, Raghuram Rajan put on his reading glasses, searched for a piece of paper in his policy documents and smiled: "You know I have a prepared statement on that. As far as the question of my continuing in this position goes, it would be cruel of me to spoil all the fun the press is having with all its speculations. I am personally intrigued by all the letters I am supposed to have written. Seriously, in all such cases, a decision is reached after discussion between the government and the incumbent. I am sure you will know when there is news. I cannot do better than point you to statements of the finance minister and prime minister on this... That's all I have to say."