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Repo Rate and Policy Tone Maintained at 6% and Neutral Respectively

Dec 6, 2017

The Reserve Bank of India today decided to keep the policy repo rate unchanged at 6% in an “effective” 5-to-1 vote. 5 voted for status quo, while Dr. Ravindra Dholakia voted for a 25bps cut.

The MPC maintained its neutral stance on monetary policy and achieving a medium-term target for CPI of 4% ± 2%, while supporting growth.

Key highlights

Domestic Macro Conditions Possibly on the Mend

Real GVA finally showed some pick up in Q2FY18 (real GDP print came in at 6.3% after 5.7% in Q1FY18) after five consecutive quarters of deceleration. This was mainly driven by the manufacturing sector on improved demand and re-stocking post GST implementation. However, lower than expected kharif harvest hampered agriculture and Services was also modest. While Gross Fixed Capital Formation improved for the second successive quarter, on the demand side, private final consumption expenditure slowed to an eight-quarter low in Q2FY18.

Core industries growth was flat in Oct-17, the PMI rebounded in Nov-17 (after a decline in Oct-17) with a positive outlook for Q3FY18 per RBI’s Industrial Outlook Survey (IOS), which sees rising order books.

Global Economic Health Appearing in Good Shape

Advanced Economies (AEs) have bolstered global economic activity with the U.S. showing resilient growth (highest pace in last 3 years in Q3CY17) despite the hurricanes and Japan and the Euro area as well showing expansion in economic activity. U.S. equity markets have gained on improved corporate earnings and anticipation of large tax cuts.

Among Emerging Economies (EMEs) China was driven by its Services sector and Brazil likely gained momentum in Q3CY17 while Russia moderated on weaker industrial production. In general, EMEs have reported gains in their equity markets, though their bond yields have shown side-ways to spiking movement on country-specific risk factors.

CPI Nearing Tolerable Medium-Term Limit

Retail inflation came in at 3.58% for Oct-17 (a 7-month high) driven mainly by strong vegetables, fruits, milk and eggs. Fuel inflation also accelerated on LPG, kerosene, coke and electricity uptick. Crude oil prices touched a two-and-a-half-year high in early Nov-17 because of the OPEC’s efforts to rebalance the market.

RBI’s household survey showed inflation expectations firming up in the latest round for both three months ahead and one year ahead horizons. Farm and industrial raw material costs rose in Oct-17. Firms responding to the RBI’s Industrial Outlook Survey expect to pass on the increase in input prices to their output prices.

Market Reactions

Ten-year yields marginally erased gains to 7.04% by the close of day from 7.06%. Ten-year yields over the past few weeks have been driven higher on the back of RBI’s expectations of firming inflation, as well as the potential rising borrowing needs of the government.

The benchmark NIFTY50 index closed down -0.73% likely as the RBI chose to stay the course and not lower interest rates (thus potentially spurring corporate credit growth) and the INR weakened -0.13%.


In its last meeting in Oct-17, the MPC had projected 4.2-4.6% inflation in H2FY18. Firming CPI excluding food and fuel, peaking HRA in Dec-17 and its subsequent multiplier effects, strength in Crude Oil prices on OPEC’s decision to maintain production cuts through next year should stoke up CPI projections, marginally offset by some seasonal moderation in certain food items (pulses) and lower retain prices from a downward GST rate revision. Net-net the MPC estimates 4.3-4.7% in H2FY18.

Potential spikes in inflation could also stem from likely pressure on fiscal deficit from farm loan waivers and partial GST implementation on petroleum products (i.e. partial withdrawal of excise and VAT).

The RBI reiterates its real GVA projection for FY18 at 6.7% with likely negative impacts from peaking Crude Oil hurting corporate margins and shortfall from kharif and rabi sowing offset by pick-up in credit growth potentially fueled by the PSU bank recapitalization.

The next meeting of the MPC is scheduled on 07-Feb-18.

With headline CPI nearing the RBI’s medium term tolerable limit of 4%, the MPC has adopted a wait-and-watch approach. Consequently, the RBI’s monetary policy opted not to lower the cost of money and rather wait for the Government’s recent initiatives (Bharatmala, PSU recapitalization, GST implementation etc.) to play themselves out on the fiscal front.