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RBI retains repo rate at 6%, raises inflation projection to 4.3-4.7% for Q3-Q4

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The Reserve Bank of India (RBI) today kept its key policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.0 percent in keeping with its aim of keeping inflation under control while supporting growth.
 
Consequently, the reverse repo rate under the LAF remains at 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.25 per cent.
 
"The decision ... is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth," the central bank said in its Fifth Bi-monthly Monetary Policy Statement, 2017-18 on the basis of the resolution of its Monetary Policy Committee (MPC).
 
The resolution said the decision was taken on the basis of an assessment of the current and evolving macroeconomic situation at today's meeting of the MPC.
 
The statement said that, among the MPC members, Dr. Chetan Ghate, Dr. Pami Dua, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and RBI Governor Urjit R. Patel were in favour of the monetary policy decision, while Dr. Ravindra H. Dholakia voted for a policy rate reduction of 25 basis points. The minutes of the MPC’s meeting will be published by December 20, 2017, it said.
 
Among other things, the RBI marginally raised its inflation projection for the remainder of the financial year, saying it estimated inflation to be in the range of 4.3-4.7 percent in the  third and fourth quarters, including the impact of increase in house rent allowance (HRA) by the Central Government of up to 35 basis points, with risks evenly balanced.
 
The October bi-monthly statement had projected inflation to rise and range between 4.2-4.6 per cent in the second half of this year, including the impact of increase in HRA.
 
The resolution said the headline inflation outcomes had evolved broadly in line with projections. Going forward, the inflation path will be influenced by several factors. First, moderation in inflation excluding food and fuel observed in Q1 of 2017-18 has, by and large, reversed. There is a risk that this upward trajectory may continue in the near-term. Second, the impact of HRA by the Central Government is expected to peak in December. The staggered impact of HRA increases by various state governments may push up housing inflation further in 2018, with attendant second order effects. Third, 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," it said.
 
Despite recent increase in prices of vegetables, some seasonal moderation is expected in near months as winter arrivals kick in. Prices of pulses have continued to show a downward bias. The GST Council in its last meeting has brought several retail goods and services to lower tax brackets, which should translate into lower retail prices, going forward, the statement noted.
 
Turning to GVA projections, the resolution said Q2 growth was lower than that projected in the October resolution. 
 
"The recent increase in oil prices may have a negative impact on margins of firms and GVA growth. Shortfalls in kharif production and rabi sowing pose downside risks to the outlook for agriculture. On the positive side, there has been some pick up in credit growth in recent months. 
 
"Recapitalisation of public sector banks may help improve credit flows further. While there has been weakness in some components of the services sector such as real estate, the Reserve Bank’s survey indicates that the services and infrastructure sectors are expecting an improvement in demand, financial conditions and the overall business situation in Q4. Taking into account the above factors, the projection of real GVA growth for 2017-18 of the October resolution at 6.7 per cent has been retained, with risks evenly balanced," it said.
 
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The MPC noted that the evolving trajectory needs to be carefully monitored. First, two of the key factors determining the cost of living conditions and inflation expectations -- 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. Second, rising input cost conditions as reflected in various surveys point towards higher risk of pass-through to retail prices in the near term. Third, implementation of farm loan waivers by select states, partial roll back of excise duty and VAT in the case of petroleum products, and 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. Fourth, global financial instability on account of the pace of/uncertainty over monetary policy normalisation in AEs and fiscal expansion in the US carry risks for inflation. 
 
"The expected seasonal moderation in prices of vegetables, and fruits and the recent lowering of tax rates by the GST Council could mitigate upside pressures. Accordingly, the MPC decided to keep the policy repo rate on hold. However, keeping in mind the output gap dynamics, the MPC decided to continue with the neutral stance and watch the incoming data carefully. The MPC remains committed to keeping headline inflation close to 4 per cent on a durable basis," it said.
 
In the MPC’s assessment, there have been several significant developments in the recent period which augur well for growth prospects, going forward. First, capital raised from the primary capital market has increased significantly after several years of sluggish activity. As the capital raised is deployed to set up new projects, it will add to demand in the short run and boost the growth potential of the economy over the medium-term. Second, the improvement in the ease of doing business ranking should help sustain foreign direct investment in the economy. Third, large distressed borrowers are being referenced to the insolvency and bankruptcy code (IBC) and public sector banks are being recapitalised, which should enhance allocative efficiency. 
 
"However, the MPC notes that the impact of these factors can be buttressed by reducing the cost of domestic borrowings through improved transmission by banks of past monetary policy changes on outstanding loans," the statement said.
 
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