The Reserve Bank of India (RBI) has left key interest rates unchanged at 6%, citing the need to control inflation which reached a seven month high in October. On December 6th, the RBI reiterated that it was maintaining a “neutral” stance on its monetary policy holding the repo rate at 6% and the reverse repo rate at 5.75%. The repo rate (short for repurchasing rate) refers to the rate at which the RBI lends to commercial banks. At present, all loans including; personal, mortgage, car and so on are linked with the marginal cost of funds based lending rate (MCLR) of banks. With the repo rate unchanged, the cost of funds for a bank will also remain the same, hence there will be no consequential decline in the MCLR.
The decision to maintain rates has been criticised by the government’s economic advisory council who have suggested that the RBI have “sacrificed output.” The government does not share the same sentiment as the RBI when it comes to inflation and have even suggested that the RBI’s figures have been “overestimated.” The government believes that lower rates would be beneficial for corporate and retail customers and thereby boost growth. In response, the RBI have argued that the recent economic slowdown is a temporary effect caused by the implementation of the new tax regime and that the economy is likely to grow as businesses adjust.
The decision to maintain rates comes after US based credit rating agency Fitch cut its projection of India’s GDP outlook from 6.9% to 6.7%. The ratings agency has attributed the slowdown to one-off factors, notably the demonetisation programme implemented November 2016 as well as disruptions related to the implementation of the GST (goods and services tax) in July 2017. However, some remain more sanguine about the prospects of the Indian economy. Credit ratings agency Moody’s upgraded India’s credit rating from Baa3 to Baa2 stating that increased productivity in the manufacturing sector and business adjustment to the new tax regime is expected to contribute to higher growth. Taking a similar stance, Morgan Stanley stated that the Indian economy is expected to witness a cyclical growth recovery, with real GDP growth expected to increase from 6.4% this year to 7.5% in 2018. The investment bank is confident about prospects of a recovery, stating that corporate return expectations and balance sheet fundamentals are improving as both consumption and exports have increased following the GST implementation.
The RBI’s decision to recapitalise public sector banks has also contributed to growth through augmenting credit flows. In October, India’s finance minister Arun Jaitley announced plans to recapitalise public sector banks with Rs. 2.11 lakh crore (approx $60.76 billion) in a bid to boost private investment. The plan, which is the largest such undertaking in India to date, is expected to be spread over two years to improve banks’ finances and revive the economy. The RBI’s recapitalisation plan has already boosted foreign capital inflows into equities, which grew sharply in October.
As a central bank it is necessary to be cautious about inflation and therefore it is unsurprising that the RBI have taken a conservative approach in setting interest rates. Although GDP growth has slowed in recent quarters, future prospects for the Indian economy seem promising. Against the backdrop of a brighter macro outlook, a rate hike can be expected in the second half of 2018.