RBI moves to take cash out of markets

Inflation concerns cited as primary reason to hold rate

Interest rates are unlikely to fall in the near term as the Reserve Bank of India on Thursday kept its key policy rate (repo rate) unchanged citing upside risk to inflation while increasing the reverse repo rate by 25 basis point to drain out excess liquidity from the banking system.

Following the decision, the repo rate under the liquidity adjustment facility (LAF) remains unchanged at 6.25 per cent whereas the reverse repo rate, which is the rate at which RBI borrows money from the banks stands at 6 per cent.

While the narrowing of gap between the repo rate and reverse repo rate is part of RBI’s longterm effort in achieving neutral liquidity position (neither excess or deficit), banking industry experts said this decision in the backdrop of abundance liquidity in the system caused due to demonetisation suggests that the central bank is in favour of tightening of yields in the short term.

“This could also be viewed as an indication of RBI’s policy stance inching towards tightening from neutral after announcing neutral from accommodative in the month of February 2017,” said Devendra Pant, chief economist, India Ratings & Research.

“The narrowing of the corridor is perhaps an indication that RBI may not allow the term structure of interest rates to decline meaningfully against the backdrop of abundant liquidity. This may be an attempt to ensure that inflationary expectations are firmly anchored and acknowledgement of surplus liquidity remaining in the system longer than anticipated,” added Soumya Kanti Ghosh, chief economic advisor, SBI.

While stating that the risks are evenly balanced around the inflation trajectory at the current juncture, RBI said there are upside risks to the baseline projections.

“The main one stems from the uncertainty surrounding the outcome of the south west monsoon in view of the rising probability of an El Niño event around July-August, and its implications for food inflation,” the Reserve Bank of India noted.