The Reserve Bank of India Surprises Markets; Holds Key Rate 1

Repo rate unchanged

The Reserve Bank of India – India’s central bank – held its key repo rate at 6.25% after its two day meeting concluded on February 8, 2017. This was the central bank’s sixth bi-monthly meeting and the last one for financial year 2016-17. In India, a financial year begins in April, and ends in March of the succeeding year.

The meeting marked the second successive occasion in which the central bank maintained status quo on the repo rate. The last time India had witnessed a rate cut was in October 2016 when the central bank had reduced the key rate by 25 basis points. That was the first time the monetary policy decision was taken under the aegis of the MPC (Monetary Policy Committee).

Prior to that, the governor of the central bank was the primary decision maker on monetary policy and interest rates.

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Markets surprised

The status quo on the repo rate surprised financial markets. Several consensus estimates had shown that a 25 basis point reduction was expected by a majority of respondents.

The primary reason why market participants had expected a rate cut was because they expected monetary support from the central bank considering the expected negative impact of demonetization on the country’s economy. The Reserve Bank’s decision not to slash the repo rate in its December meeting had elicited a similar surprise.

Another reason which had led participants to believe the Reserve Bank of India would make its monetary policy even more accommodative was inflation. India’s retail inflation has been in the 3-3.5% range in the past few meetings, and considering the negative impact of demonetization on consumption, markets had taken a benign view on inflation and expected a rate cut.

But the repo rate remains unchanged, and with the last meeting of 2016-17 in the past, the financial year has witnessed two rate cuts for a combined 50 basis points.

We have seen why markets had expected a rate cut. In the next article, let’s see why the Reserve Bank of India refrained from a rate cut.

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