MUMBAI (Reuters) - The Reserve Bank of India (RBI) kept its policy rate on hold at 6.75 percent on Tuesday, as widely expected, opting to wait until after the government’s annual budget statement at the end of February to decide on whether to cut interest rates further.
Having cut the policy repo rate by 125 basis points in 2015, RBI Governor Raghuram Rajan warned on Friday against straying from the path of fiscal consolidation or relaxing the fight against inflation.
Rajan, in his statement on Tuesday, said the central bank would stay “accommodative” but would look forward to the government’s budget on Feb. 29, saying it needed to be one that supports growth and controls spending.
How the government implements a planned 24 percent pay hike in salaries and pensions for some 10 million current and former government employees will also be key in determining the path of inflation, he noted.
“The Reserve Bank continues to be accommodative even as it leaves the policy rate unchanged in this review, while awaiting further data on the development of inflation,” Rajan said in his statement.
“Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth.”
Rajan also reiterated the central bank would ensure it is injecting sufficient liquidity into the banking system including conducting more open market operation bond purchases.
Banks have blamed the lack of cash in the financial system for their inability to match the RBI rate cuts last year, with most banks having lowered lending rates by only about 60 bps.
The 10-year bond yield rose around 5 basis points to 7.83 percent from levels before the decision, but the rupee and the NSE share index were broadly range-bound.
If the fiscal deficit is kept within reason, then inflation trends over coming months could also favour hopes for lower interest rates.
The RBI will have to keep watch over developments in global markets that began this year in a jumpy state.
Other major central banks, notably the Bank of Japan and Bank Indonesia have eased monetary policy, and the European Central Bank is expected to ease too, though the U.S. Federal Reserve is expected to raise rates later this year.
Oil prices near 13-year lows and seasonally subdued food price should help bring inflation down to the RBI’s target of 5 percent by March 2017, after it hit a 15-month high of 5.61 percent in December.
Only 37 out 39 economists polled by Reuters had expected the RBI to leave the policy repo rate unchanged for now.
But more than half of them saw scope for at least a 25 bps rate cut by the end of June thanks to the reduced inflationary pressures, with some saying the reduction could come as early as March, before the next scheduled policy review in April.
“If the government’s budget looks to boost growth through reforms and keeping spending under check, we expect an inter-meeting cut post the budget - 25 basis points, may be even 50 bps,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors in Mumbai.
There is growing impatience with Prime Minister Narendra Modi’s government to deliver stronger growth, as vaunted economic reforms keep getting delayed.
The headline growth rate looks very creditable, with the RBI projecting 7.4 percent for the year ending in March, albeit with a downward bias, and 7.6 percent growth for 2016/17. But private sector investment remains weak, and India needs sustained growth of around 8 percent to generate jobs for its growing workforce.
Analysts expect India’s budget to slightly raise fiscal deficit targets to free up money for investment in infrastructure projects, while keeping subsidies and other spending under control.
Editing by Simon Cameron-Moore