RBI holds key repo rate at 6.25%, decides to change stance to neutral

09 Feb 2017 Evaluate

The Monetary Policy Committee (MPC) of the RBI, headed by Urjit Patel, unanimously decided to hold the key repo rate at 6.25 percent in its sixth bi-monthly policy review of the financial year 2016-17. Accordingly, the reverse repo rate at which it absorbs excess liquidity was retained at 5.75 percent, the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent. Importantly, the committee said that it decided to change the stance from accommodative to neutral, while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and the output gap play out.

The Reserve Bank of India (RBI) has said that all the six members of the MPC voted in favour of the decision. It also said that the decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 percent by Q4 of 2016-17 and the medium-term target of 4 percent within a band of +/- 2 percent, while supporting growth. The MPC said it is committed to bringing headline inflation closer to 4.0 percent on a durable basis and in a calibrated manner and this requires further significant decline in inflation expectations, especially since the services component of inflation that is sensitive to wage movements has been sticky.

Talking about growth, RBI said that growth is expected to recover sharply in FY18. It said this can be triggered by revival in discretionary demand held back by demonetisation; pick-up in economic activity in cash-intensive sectors such as retail trade, hotels and restaurants, and transportation, as well as in the unorganised sector; and pick-up in both consumption and investment demand. RBI revised down its growth projection to 6.9 percent for FY 2016-17 from 7.1 percent estimated earlier, but added that it will pick up sharply to 7.4 percent in FY 2017-18. It also said that the current account deficit (CAD) is likely to remain muted and below 1 percent of GDP in 2016-17.

The central bank further noted that the environment for timely transmission of policy rates to banks lending rates will be considerably improved if (i) the banking sector’s non-performing assets (NPAs) are resolved more quickly and efficiently; (ii) recapitalisation of the banking sector is hastened; and, (iii) the formula for adjustments in the interest rates on small savings schemes to changes in yields on government securities of corresponding maturity is fully implemented.

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