By Sravya Vemuri

The Reserve Bank of India (RBI), on February 7th, announced its sixth bi-monthly monetary policy statement for 2017-18 and kept the rates unchanged. However, the central bank warned of a spike in the prices and volatile financial markets, implying that its ability to foster growth might be limited.

Neutral stance

In the last two months, the bond yields have spiked by about 75 basis points. Also, banks have raised the interest rates. Even with RBI maintaining a neutral stance, the borrowing has now become costlier. In an accommodative monetary policy, central banks lower the interest rates in order to increase the money supply. This would induce growth in the economy (at the risk of inflation). The opposite of this is contractionary policy, which means that RBI thinks that the economy is getting into inflation and that time has come to increase the interest rates to restrict the money supply. The significance of a neutral stance is not that RBI is neutral, but that RBI is no more accommodative.

In its fifth bi-monthly policy, the Monetary Policy Committee (MPC) decided to keep the repo rate under the Liquidity Adjustment Ratio (LAR) unchanged at 6.0 percent. The main considerations underlying this decision were that the global economic activity has been gaining momentum during the last quarter of 2017 especially due to the advanced economies. Global financial markets have remained buoyant, reflecting the improving economic outlook and the gradual normalisation of monetary policy by the US Federal bank.

A balancing act

The RBI kept the 6.0 percent rate unchanged for the third straight time so as to make a balancing act. The RBI’s medium term target for Consumer Price Inflation (CPI) was 4 per cent. However, this was breached due to the rising oil prices and food prices. This pushed the Indian economy’s consumer Inflation to its 17- month high 5.21 percent in December 2017. The policy stated that tightening the economy would render the development ineffective at a time when India is recovering from its slowest growing pace in three years.

Concerns over budget

The RBI took an advantage of low inflation in the year 2015 by decreasing the repo rate by 25 bps in August of 2015. However, the inflation is predicted to be accelerating after the budget presentation by the government. The budget proposed for widening the fiscal deficit so as to increase its investments in total and health sectors. The governor of RBI Urjit Patel has expressed concerns over the same. The RBI said that it expected the inflation to rise to 5.1 to 5.6 per cent in April, from 5.1 per cent in the first three months of 2018. The central bank then said inflation would soften to 4.5-4.6 percent in October-March, due to normalised food prices and a favourable base effect.

Gross value added

The central bank, in its earlier reports expected the Gross Value Added (GVA) to grow at 6.7 per cent for the year 2017-18. In its statement on Wednesday, the back revised the estimate for GVA growth from 6.7 per cent to 6.6 percent. For 2018-19, the RBI projected GVA growth at 7.2 percent—in the range of 7.3- 7.4% in the first half of the fiscal and 7.1-7.2% in the second half—with risks evenly balanced. The governor said that as recapitalisation of public sector banks is in process and the defaulters are being referred to by the Insolvency and Bankruptcy Code (IBC), the credit flow is supposed to be increased and creates demand for new investments. GVA is an important measure of the health of economy as it serves as an indicator of the productivity by excluding indirect taxes which usually distort the production process.

India’s economy is expected to grow 7.0-7.5 percent in the 2018/19 fiscal year, below the 8 percent pace economist say is needed to create enough jobs for its youth. The reporters were told that it was a prudent option to stay on the same course.

Featured Image Source: Pexels

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