The Reserve Bank of India (RBI) in its first bi-monthly monetary policy review of 2017-18 on Thursday kept its key lending rate unchanged at 6.25 % and increased Reverse Repo Rate to 6%.
After moderating continuously over the last six months to a historic low, retail inflation measured by year-on-year changes in the consumer price index (CPI) turned up in February to 3.7 per cent.
Commenting on the monetary policy for 2017-18, SBI Chairperson Arundhati Bhattacharya said the RBI policy to keep the repo rate on hold was on expected lines, even though reverse repo rate was hiked to 6 per cent.
The second worry arises from the GST implementation and the third upside risks to inflation comes from the seventh pay commission award.
All 50 economists in a Bloomberg survey predict the Reserve Bank of India will leave the repurchase rate unchanged at 6.25 percent on Thursday, as price pressures appear to be picking up.
Thus, the Monetary Policy Committee, which has three RBI members, including the governor as the chairman, has unanimously chose to hold the policy rates steady.
In either situation of tight liquidity or excess liquidity, the RBI's objective remains the same - to ensure that the key policy rate (repo) is the operational rate. One, the overnight rate will now move closer to the repo rate at 6.25 per cent. After demonetisation, there had been a surge in liquidity in the system and the RBI has had to device ways to absorb it, said the governor.
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The repo rate helps control inflation. It is noteworthy that the RBI has persisted with its neutral stance despite its own projection pointing towards somewhat higher inflation vis-à-vis the target of 4% over the course of next two years.
"The Monetary Policy Committee took note of the reduction in bank lending rates but saw further scope in a complete reduction, including for small savings and administered rates", Governor Urjit Patel told reporters.
The surge came come after the government past year removed higher-value bank notes from circulation, leading to huge deposits of the banned bills.
In February, the committee again surprised by holding rates and switching to a "neutral" stance from "accommodative" - a move that made bond yields spike. In a falling rate cycle, pass-through of rate cuts will happen quickly if there is sufficient liquidity in the system, as banks will be able to lower deposit rates comfortably.
"The increase in reverse repo is a step towards a single policy rate regime, where MSF will be 25 bps above repo and SDF will be 25 bps below repo".
Equity markets in AEs were driven up by reflation trade, stronger incoming data and currency movements.
The RBI continues to show its commitment to driving system liquidity closer to neutrality with all the tools available with itself for the moment, he added.