RBI keeps policy rate unchanged; flags inflation, deficit

Retail inflation crossed the RBI's comfort level and rose to 5.21 per cent in December on increase in prices of food items.

Illustration: Dominic Xavier/Rediff.com

The Reserve Bank on Wednesday opted for the widely expected status quo in key rates citing inflation concerns and flagged risks from wider fiscal deficit.

The repo rate, at which the central bank lends short-term money, will continue to stay at 6 per cent. The reverse repo, rate at which it borrows from banks and absorbs excess liquidity, will remain at 5.75 per cent.

The resolution of the 6-member Monetary Policy Committee (MPC) said "the inflation outlook is clouded by several uncertainties on the upside", flagging risks from 7th pay panel implementation in states, high oil prices, hike in customs duties and fiscal slippage to 3.5 per cent in 2017-18 and a higher target for 2018-19.

"Fiscal slippage as indicated in the Union Budget could impinge on the inflation outlook. Apart from the direct impact on inflation, fiscal slippage has broader macro-financial implications, notably on economy-wide costs of borrowing which have already started to rise. This may feed into inflation," it warned.

Deterioration in public finances risks crowding out of private financing and investment, it said, adding that the nascent recovery needs to be carefully nurtured.

RBI said however that it is too early to assess the impact of the minimum support prices hike in foodgrains and the impact on inflation.

RBI also upped its inflation forecast to 5.1 per cent for the ongoing fourth quarter of 2017-18 and expects it to firm up further to 5.1-5.6 per cent in first half of the next fiscal, before cooling down to 4.5-4.6 per cent in the second half.

On the positive side, MPC said there are mitigating factors like subdued capacity utilisation and moderate growth in rural wage, while welcoming the focus of Union Budget 2018-19 on rural and infrastructure spending.

RBI also lowered its growth target to 6.6 per cent for the current fiscal ending on March 31, from 6.7 per cent earlier, but said that it will accelerate to 7.2 per cent in 2018-19.

Five members of the panel, including RBI Governor, voted for a status quo while executive director Michael Patra was the lone member who wanted the key rate to be hiked.

On volatility in global financial markets, RBI said it is due to uncertainty over the pace of normalisation of the US Fed monetary policy.

A majority of watchers were expecting the MPC to go for a status quo in rates with a hawkish commentary on inflation concerns.

Inflation accelerated to 5.2 per cent in December, from the 5 per cent level in the previous month.

The RBI is bound to keep the headline price rise number at 4 per cent with a two percentage point leeway on either side.

At the last policy review, it had raised the inflation forecast to 4.3-4.7 per cent for the second half of the current fiscal.

Factors which can fuel price rise include a proposed increase in minimum support prices for grains, a rally in oil prices and the government deviating from the fiscal consolidation roadmap to target a wider 3.2 per cent deficit in 2018-19.

On the economic growth front, there has been some improvement as the effects of the twin blows of demonetisation and GST implementation are waning.

The government is expecting a 7-7.5 per cent growth in 2018-19.

The RBI had switched stance to neutral from being accommodative in February last year as it saw rise in inflation.

It had last cut the repo rate by 0.25 per cent in the August 2017 monetary policy review.