lower inflation gave room for rate cut, but risks remain: Patel

Given the urgent need to reinvigorate investment in India, the falling trajectory of core inflation over the last quarter opened up room for the 25 basis points cut in the Reserve Bank of India's key interest rate, RBI Governor Urjit Patel said on Wednesday.

"The Monetary Policy Commitee (MPC) noted that some of the upside risks to inflation have either reduced or not materialised. Consequently, some space has opened up for monetary policy accommodation, given the dynamics of the output gap. Accordingly, the MPC decided to reduce the policy repo rate by 25 basis points," the RBI statement said here announcing its third bi-monthly policy review.

The Reserve Bank of India on Wednesday cut its repo, or short-term lending rate for commercial banks, to 6 per cent from 6.25 per cent. 

The Governor told reporters here following the policy announcement that with inflation expected to rise, the MPC decided to maintain its neutral policy stance. 

"The trajectory of inflation in the baseline projection is expected to rise from current lows," Patel said.

"So, the MPC decided to keep the policy stance neutral and to watch incoming data. The MPC remains focused on its commitment to keeping headline inflation close to 4 per cent on a durable basis. Our stance is what it should be and what it was in June," he added. 

Retail inflation in India during June dropped to a record low of 1.54 per cent, while industrial production data showed that the growth in factory production fell to 1.7 per cent in May, from 8 per cent in the same month a year ago.

"The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway," the RBI said. 

"The MPC noted that while the outlook for agriculture appears robust, underlying growth impulses in industry and services are weakening, given corporate deleveraging and the retrenchment of investment demand," it added. 

The Governor outlined the various factors that constitute upside risks to inflation, including farm loan waivers by states and their implementation of salary and allowances increase for employees. 

"If states choose to implement salary and allowance increases similar to the Centre in the current financial year, headline inflation could rise by an additional estimated 100 basis points above the baseline over 18-24 months," the policy statement said. 

"Also, high frequency indicators suggest that price pressures are building up in vegetables and animal proteins in the near months," it added. 

While four members of the panel, including the Governor, voted in favour of reducing the key lending rate, one member voted for maintaining status quo. One of the three government nominees on the committee, Rajendra Dholakia, voted for a 50 bps cut in the repo rate, in the same manner that he had recommended at the previous policy review in June.