The banking regulator has cited increasing food inflation and rising uncertainty in global markets for this unexpected move.
Contrary to what many analysts expected, RBI, in its fifth bi-monthly review, has surprised the markets by keeping the repo rate unchanged. The repo rate and reverse repo rate remain unchanged at 6.25% and 5.75% respectively.
However, the banking regulator has raised the requirement of maintaining 100% of incremental inflows in the cash reserve ratio (CRR). RBI had introduced this move to absorb excess liquidity in the banking system arising out of demonetization.
The banking regulator has expressed concerns over increasing food inflation and rising uncertainty in global markets. RBI has said, “Global growth picked up modestly in the second half of 2016, after weakening in the first half. Activity in advanced economies (AEs) improved hesitantly, led by a rebound in the US. In the emerging market economies (EMEs), growth has moderated, but policy stimulus in China and some easing of stress in the larger commodity exporters shored up momentum. Turning to inflation, food prices other than vegetables are exhibiting sustained firmness and a pick-up in momentum. Another disconcerting feature of recent developments is the downward inflexibility in inflation excluding food and fuel which could set a resistance level for future downward movements in the headline.”
Lakshmi Iyer, Chief Investment Officer (Debt) & Head of Products, Kotak Mutual Fund says that RBI seems to be awaiting further data to assess impact of demonetization on growth. "Unchanged policy rate was a surprise for the market. Hardening of yields in most of the developed nations along with forex volatility, may have heightened RBI's risk perception. Also, the spike in international oil prices and stickiness in inflation seems to outweigh concerns for growth. RBI's lower projection of growth of real gross value added (GVA) is because of lower Q2 numbers rather than its estimate on slowdown due to demonetization. RBI's assessment of inflation continues to be at 5% by Mar-2017. We believe that CPI inflation would be at around 4.5% by Mar-2017 and thus expect that RBI has a 25-50 bps window for effecting a rate cut in the near future. Were the economy to not perform as per expectation over next 2-3 quarters, the central banker's appetite for rate cut could increase further."
“Belying market expectations, RBI decided to keep key rates unchanged. Bond markets have expectedly reacted negatively given that 25 bps was already factored in with some segments even expecting 50 bps rate cut. RBI has clearly specified they need data and more time to evaluate the effects of demonetization and clearly do not wish to react disproportionately to short term transient effects. Global developments including sharp rise in US treasury yields and expected hike in US Fed funds rate also seems to have weighed on the policy move. And on inflation they seem to have noted the resistance of core inflation (ex food and fuel) to downward impulses,” says Bekxy Kuriakose, Head Fixed Income, Principal Pnb Asset Management.
R. Sivakumar, Head of Fixed Income, Axis Mutual Fund said, “Over the past month India has been an outlier in the world in terms of the direction of bond yields. Across the world – developing and advanced – bond yields have risen sharply on expectation of better growth and inflation. Commodity prices have risen and expectation of central bank action have changed. In this backdrop and without RBI rate cuts to support the near term outlook for long bonds in India too suggest some firming of rates. The next few months also see uncertainty from the budget, implementation of GST and the impact of demonetization. In view of this we expect to maintain somewhat lower duration in the portfolios relative to the recent past. Further, demonetization and the emphasis on cashless/digital transactions would have a structural impact on the banking system. In this context we expect short to medium term rates to remain contained. We expect short to medium term bonds to outperform as a result.”
