India's central bank 'looks through' inflation, leaves rates on hold

YDNEY, AUSTRALIA – MARCH 26: Virat Kohli of India celebrates after taking a catch to dismiss David Warner of Australia off the bowling of Umesh Yadav of India during the 2015 Cricket World Cup Semi Final match between Australia and India at Sydney Cricket Ground on March 26, 2015 in Sydney, Australia. (Photo by Ryan Pierse/Getty Images)

As expected, the Reserve Bank of India (RBI) has left policy unchanged in August, keeping its key repo rate at 7.25%.

In other policy announcements, the reverse repo rate and the bank cash reserve requirement were left at 6.25% and 4.0% respectively.

On the outlook for inflation, the RBI noted “large base effects, which the Reserve Bank will look through, are expected to pull down headline inflation in July and August”, adding “from September, favourable base effects wane”.

Here’s the key upside risks the bank sees to inflation outlook.

“Most worrisome is the sustained hardening of inflation excluding food and fuel. Moreover, the full effects of the service tax increase, which took effect from June, will feed through over the rest of the year. Some food prices, particularly of protein-rich items, pulses and oilseeds have risen sharply in recent months. They will have to be carefully monitored as they tend to be sticky and impart an upward bias to inflation and inflation expectations. This assumes significance in view of households’ inflation expectations rising again.

And to the downside:

“Several factors, however, could have a significant mitigating influence. These include the sharp fall in crude prices since June and the likelihood of this softness persisting in view of the global supply glut and expanding production by Iran; the welcome increase in planting of pulses and oilseeds and prospects of rainfall in August and September according to some forecasters; the effects of the Government’s current pro-active supply management to contain shocks to food prices, especially of vegetables, alongside its decision to keep increases in minimum support prices moderate”.

Based on the risks to the inflation outlook, and given the RBI front-loaded policy easing when they last met in June, the board noted that it was “prudent to keep the policy rate unchanged at the current juncture while maintaining the accommodative stance of monetary policy”.

“Significant uncertainty will be resolved in the coming months, including the likely persistence of recent inflationary pressures, the full monsoon outturn, as well as possible Federal Reserve actions. As the Reserve Bank awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation”, it said.

The board next meet on September 29, two weeks after the US Federal Reserve holds its crucial September FOMC meeting.

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