RBI holds key rates but warns about stimulus

Mumbai: Despite a serious slowdown in domestic growth, RBI on Wednesday decided to keep its key policy rate unchanged at 6 per cent citing upside risk to inflation. RBI also cautioned the government against any fiscal stimulus package arguing that the combined fiscal deficit of both the centre and the states are already in the region of 6 per cent of the GDP and such fiscal action could undercut India’s macro-economic stability. 

However, the central bank surprised market participants by slashing the statutory liquidity ratio (SLR), or the amount of bonds that banks must set aside with the central bank, by 50 basis points to 19.50 per cent from mid-October.  The move is likely to infuse more liquidity into the system bolstering the ability of the banks to lend more. 

With the CPI inflation rising by around 2 percentage points since its August meeting, the Monetary Policy Committee now expects inflation to range between 4.2–4.6 per cent in the second half of this fiscal year, which is well above its target of 4 per cent. 

According to RBI, the rise in inflation has coincided with the escalation of geopolitical tensions that has firmed up the prices of crude oil. While the domestic food price index has remained largely stable, RBI noted that the generalised momentum is building on prices of items excluding food, especially emanating from crude oil and some price revision in the wake of implementation of GST. 

According to RBI, there are a couple of factors that continue to impart upside risks to baseline inflation trajectory. Firstly, the implementation of farm loan waivers by states may result in possible fiscal slippages and undermine the quality of public spending, thereby exerting pressure on prices. 

Secondly, the state’s implementation of the salary and allowances award is not yet considered in the baseline projection; an increase by states similar to that by the centre could push up headline inflation by about 100 bps above the baseline over 18-24 months. “However, adequate food stocks and effective supply management by the government may keep food inflation more benign than assumed in the baseline,” RBI added.