The RBI monetary policy committee (MPC) on Wednesday announced a 25 basis points cut in the policy rate citing a sharp fall in inflation. However, it noted that there are several uncertainties to the inflation trajectory such as farm loan waiver impact on state finances and maintained the neutral stance of monetary policy.
The repo rate – at which the central bank infuses liquidity in the banking system- now stands reduced to 6%. The panel maintained its gross value added growth forecast for the current fiscal year at 7.3%. Four members of the MPC voted for a 25 basis points reduction. Ravindra Dholakia, professor at IIM Ahmedabad wanted a 50 bps cut, while Michael Patra, executive director at RBI, wanted to hold rates.
Some of the upside risks to inflation such as core inflation, poor rains and adverse impacts from the roll out of the goods and services tax have not materialised, the panel noted.
“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. Noting, however, that the trajectory of inflation in the baseline projection is expected to rise from current lows, 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 percent on a durable basis,” the monetary policy statement said.
Retail inflation accelerated 1.5% in June, lower than RBI’s April-September inflation forecast of 2-3.5%, consistently undershooting the central bank’s own forecast. The slowing of inflation is mainly due to falling food prices and a statistical base effect. However, even core inflation, which excludes food and fuel, has declined in the past two readings after remaining sticky for a while.
However, the panel isn’t fully convinced about whether inflation has structurally moved lower.
“While inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive,” the monetary policy statement said. “The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway.”