Rajan keeps policy rate unchanged on fears of food inflation

Reserve Bank Governor Raghuram Rajan today kept policy rate unchanged awaiting clarity on impact of unseasonal rains on food inflation even as he wanted banks to pass on benefits of previous two rate cuts.

The repo rate, at which RBI lends to the banking system, will continue to be at 7.5 per cent and the cash reserve ratio, which is the amount of deposits parked with the central bank, will remain at 4 per cent.

"Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and front loading of two rate cuts. With little transmission, and the possibility that incoming data will provide more clarity on the balance of risks on inflation, the Reserve Bank will maintain status quo," he said in the first bi-monthly policy review for 2015-16.

Unseasonal rains and hailstorm have impacted rabi crops across North and Western India, raising fears of spike in food prices.

Rajan, who has surprised with two rate cuts of 0.25 per cent each outside the scheduled review meetings this year, however, affirmed his commitment to the accommodative stance, but added that policy moves will be shaped by incoming data and added that transmission of rate cuts by banks will be his top-most priority.

Apart from the transmission, other factors like food prices will also be monitored closely, he said, adding that the impact of the recent unseasonal rains will also be monitored closely.

"Reserve Bank stays vigilant to any threats to the disinflation that is underway," he said, expecting that the price rise situation has so far faired according to its estimates.

On the transmission mechanism, the RBI said it will encourage banks to move to the marginal-cost-of-funds-based determination, which is "more sensitive to changes in the policy rates".

Only a few banks namely Union Bank of India and State Bank of Travancore have cut their base rates in the last four months by 0.10 per cent each, as against the 0.50 per cent cuts by RBI.

The banks have held on to the elevated rates even in the face of one of the lowest credit growths in recent years, which is hovering under the 10 per cent mark till now.

On the GDP growth, RBI estimated a 7.8 per cent expansion in the current fiscal, stating that uncertainties on the arrival of monsoon and unanticipated global developments are major risk areas.

On the external front, it said a moderate and uneven recovery is emerging, and flagged the slowdown in China, geopolitical tensions in the Middle East as downside risks.

With speculation rife about a shift in US Fed's stance to one of hiking rates, which can impact capital flows to the country, RBI said it will "watch for signs of normalisation of the US monetary policy", but added that the country is better placed to fight any impact with its over USD 343 billion in reserves.

Retail inflation increased to 5.37 per cent in February from the 5.19 per cent for previous month, but many analysts expect it to continue much below the RBI's January 2016 target of 6 per cent range.

Another factor which was supporting a rate cut included the range-bound core inflation, which is price rise without the food and oil components. The latest survey of household expectations may also be pointing towards a lower inflation, some watchers said.

However, the impact of factors like unseasonal rains on food inflation was a key impediment to the expectations of a rate cut.

Meanwhile, Chief Economic Adviser Arvind Subramanian said that  RBI's policy statement was "on expected lines".

Rajan has surprised the markets with two consecutive inter-meeting cuts of a cumulative 0.50 per cent in January and March. While the first was prompted by a dip in household expectations, the second was a consequence of the Union budget, which placated a slew of concerns including the path for fiscal consolidation.

According to experts, it is the transmission of the rate cuts into banks' lending rates which should be the primary concern for RBI. Many moves, especially on the liquidity management front, were being speculated ahead of the policy.

These included a further cut in the mandatory Statutory liquidity Ratio or the government bond holding, the cash reserve ratio on which banks earn no interest and also a hike in the reverse repo rate.

In its developmental policies, RBI today said it will allow banks to invest in the long term bonds for infrastructure and affordable housing issued by their peers, subject to certain conditions.

The investments will not be treated as assets with the banking system in India and there will be limits on the holding, it said, adding that the component held for trading will reduce a bank’s PSl (priority sector lending) benefits.

The RBI also announced that corporate will be allowed to issue rupee bonds, following the success on this front achieved by the government-run institutions and multilateral bodies.

In a significant move, RBI also said that individuals will be allowed to trade in government-bonds through non-competitive bidding platform, which is available only with institutional investors at present.

It said urban cooperative banks of certain size will also be allowed to issue credit cards.