At the third bi-monthly monetary policy review on August 9, Reserve Bank Governor Raghuram Rajan did what was largely expected of him. He let the policy rates remain unchanged. The primary reason attributing to such a stance was the retail inflation which was still more than 5 percent, much above the comfort zone.
Target inflation still away
The government announced last week that it would like the RBI to focus on maintaining the retail inflation rate of 4 per cent for the next five years, based on which the new interest rate setting panel would take its monetary policy decisions going forward. This 6-member panel may take over the job before the next policy review on October 4.
Meanwhile, the Consumer Price Index-based retail inflation rose by 5.77 per cent in June, the fastest pace in the previous 22 months. It is also expected that the implementation of the 7th Pay Commission payouts and the Goods and Services Tax (GST) in due course may bring inflationary pressure to the economy.
3 reasons why rates may not come down in a hurry
Food inflation: The recent sharper-than-anticipated increase in food prices has pushed up the projected trajectory of inflation over the rest of the year. Moreover, prices of pulses and cereals are rising and services inflation remains somewhat sticky.
Inflation minus food, fuel: The prospects for inflation excluding food and fuel are more uncertain. If the current softness in crude prices proves to be transient and as the output gap continues to close, inflation excluding food and fuel may likely trend upwards and counterbalance the benefit of the expected easing of food inflation.
Impact of 7th Pay Commission payouts: The full implementation of the recommendations of the 7th Central Pay Commission (CPC) on allowances will affect the magnitude of the direct effect of house rents on the CPI.
Further, the GST impact on inflation remains to be seen as and when it gets implemented in the country.
In April, 2016, the Reserve Bank cut the key interest rate by 0.25 per cent but kept it unchanged in its June, 2016 announcement. RBI had also enforced the marginal cost of lending rate (MCLR) from April 1 to ensure better transmission of the real policy rate. Since Jan 2015, RBI has cut the repo rate by 1.50 percent. However, banks have reduced their lending rates by about 0.5 percent. Many banks did reduce their MCLR by about .01-.05 percent, too less to make an impact. As a majority of lenders still have their loans linked to the banks’ base rates, the lending rates do not appear to be coming down in a hurry. To add to that, interest rates on small saving investments were kept unchanged by the government in spite of making their rates linked to the movement of government yields (which are rolling downwards) on quarterly basis.
As an RBI statement suggests, “Easy liquidity conditions are already prompting banks to modestly transmit past policy rate cuts through their MCLRs and pro-active liquidity management should facilitate more pass-through.” It, however, remains to be seen the impact on the cost of funds for banks and how soon they start cutting rates.