Reserve Bank of India (RBI) Monetary Policy Review

MPC keeps rates on hold, but flags upside risks to inflation in the future

Published bi-monthly by the Reserve Bank of India (RBI). Updated to the month of February 2018. (Published on February 7th, 2018).

Recent Data Trend

In the sixth bi-monthly meeting, RBI's monetary policy committee (MPC) kept the policy repo rate unchanged at 6%, sticking to its neutral stance. The decision to keep rates on hold was largely in line with the market expectations. The reverse repo and the bank rate also remained unchanged at 5.75% and 6.25%, respectively.

The MPC noted that the recent acceleration in retail inflation was largely driven by inflation in food and fuel segment. Also, it highlighted the continued rise in core inflation (headline inflation and fuel). RBI attributed the steady rise in core inflation to housing inflation which has continued to rise for the past six consecutive months reaching a high of 8.25% YoY in December. The retail inflation averaged 4.6% for the Oct-Dec quarter, slightly within RBI's projected inflation range of 4.3-4.7% for Oct 2017-March 2018 (H2 2017-18). In this context, the MPC raised its inflation projections for Q4 2017-18 to 5.1% YoY, thus, expecting the inflation for H2 2017-18 to average around 4.8%, slightly above its December estimates of 4.3-4.7%.

For the fiscal year 2018-19, RBI expects inflation to average around 4.8-5.2% for the year, above its medium-term inflation target of 4%.

The MPC didn't go for a rate hike but flagged upside risks to inflation in the future. Firstly, an upward pressure from rising crude oil prices, followed by the continuing impact of the house rent allowance (HRA) will increase inflation in the fuel and housing segment. Secondly, the increase in Minimum Support Prices (MSP) for kharif crops (1.5 times above the cost of production) in the recently released Union Budget for 2018-19, is likely to put pressure on food prices.

Lastly, the risks of fiscal slippages (the Centre has revised its fiscal deficit target to 3.5% of GDP for 2017-18, from the earlier target of 3.2% of GDP) can have a direct impact on inflation via the channel of economy-wide higher costs of borrowing.

In our view, if most of the upside risks to inflation cited by the MPC materializes, RBI may go for its first rate hike in over four years in its next meet scheduled for April 5, 2018.

Brief Overview
RBI's monetary policy has emerged as a critical policy tool for achieving overall macroeconomic management, price stability, and growth. The conduct of monetary policy has evolved over time on the front of the policy framework and operating procedure. Back in the 1980s, when the economy was plagued by high inflation fuelled by excessive money supply in the form of RBI credit to government, price stability became utmost important. So, RBI adopted "monetary targeting with feedback" (targeting money supply) as the monetary policy framework suggested by the Chakravarty Committee (1985).

With the development of the financial sector, liberalization of the economy (1991) and freeing up of interest rates and exchange rates, RBI shifted its focus from exclusive reliance on monetary aggregates to a broad set of indicators. Therefore, in 1998-99 RBI started pursuing the multiple indicators approach only to later face problems associated with fulfilling multiple objectives.

However, on the recommendations of Urjit Patel Committee (2014), RBI shifted to a new monetary policy framework of "inflation targeting". Since 2014-15, RBI has kept its mandate of achieving price stability and growth via inflation targeting.

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Next Release Date: April 5th, 2018