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.
"Inflation is definitely headed higher and there are also talks that there could be some fiscal slippage", said Indranil Pan, chief economist at IDFC Bank Ltd.in Mumbai. Reiterating the urgent imperative to "reinvigorate investment activity" to spur growth, the MPC has laid the onus squarely on the government's shoulders: from suggesting the recapitalisation of stressed state-owned lenders, to calling for further simplification of the GST regime and urging that stalled public sector investment projects be restarted.
With the Gross Domestic Growth (GDP) slipping to 5.7 percent for the April-June quarter from 7.9 percent in the same quarter past year, the Central government wanted another possible rate cut from the RBI, with an aim to help the economy recover from its current low and to increase lending activities.
Should demand stay low, there might be a downward revision in rates and vice versa. Though the government has stuck to its budgeted borrowing target for this fiscal and also committed to meet the fiscal deficit target of 3.2%, it has not ruled out additional borrowing after a review in December.
Consequent to the decision to maintain the repo rate, the reverse repo rate remained at 5.75 per cent.
Among the sectoral indices, the S&P BSE Healthcare index gained 2 percent followed by energy 1.8 percent and consumer goods 1.6 percent.
The panel proposed to remove some of the leeway that banks have enjoyed, including allowing lenders to use only one of three benchmarks to set their lending rates: the policy repo rate, Treasury bill rates or certificate of deposit rates.
And it added that India would grow at 6.7% in 2017-18.
Much would also depend on how vigorously the central bank is willing to enforce the rules. In view of the primary mandate of the CBN which is to maintain price and exchange rate stability, it will be near impossible for the apex bank to pursue lower inflation and interest rates, maintain exchange rate stability and shore up foreign exchange reserves all at the same time.
But as it seeks to now focus on inflation, the RBI is bound to face pressure from government officials and executives to help prop up an economy that in months has gone from one of the fastest expansions in the world to growing only 5.7 percent in April-June, well below the 8 percent needed for full employment.
All of that had many clamouring for a rate cut.
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