Reserve Bank of India on Tuesday kept its policy rates unchanged, with Governor Raghuram Rajan saying that the headline inflation is at elevated levels and banks are yet to pass on the full benefits of previous rate cuts.
RBI has cut the rates thrice so far in 2015 by 25 basis points each.
Stating that the policy action was front-loaded in June, Rajan said it is prudent to keep the policy rate unchanged at the current juncture while maintaining the accommodative stance of monetary policy.
As the RBI awaits greater transmission of its front-loaded past actions, it will monitor developments for emerging room for more accommodation, Rajan said while announcing the third bi-monthly policy review of the current fiscal.
Accordingly, the repo rate at which the RBI lends to the system, will continue to be unchanged at 7.25 per cent and the cash reserve ratio, which is the proportion of deposits banks have to park with the central bank, will remain 4 per cent.
The central bank was widely expected to maintain status quo on Tuesday.
Rajan said significant uncertainty on the factors influencing the monetary policy will be resolved in the coming months, including persistence of high inflation, monsoon as well as actions by the US Federal Reserve which is expected to shift to hiking rates.
He reiterated that the accommodative stance of the RBI adopted this year was based on factors like transmission of RBI cuts by banks into their lending rates, food prices and monsoon, action from the government on the supply side and signs of normalisation in the US.
Rajan, who has used strong words against banks for holding on to rates in the April and June, on Tuesday said banks have only cut 0.30 per cent at the median level as against the RBI s cut of 0.75 per cent this year.
He hoped that with a likely pick-up in loan demand from the third quarter, banks will see more gains from cutting rates to secure new lending and transmission will take place.
Welcoming the government move to infuse more capital into state-run banks, Rajan said it will help both loan growth as well as transmission as the liquidity conditions ease.
On inflation, he said the June reading of 5.4 per cent has resulted in the projections being elevated, but exuded confidence of meeting the 6 per cent target for early 2016.
However, THE most worrisome factor is the hardening in the non-food and fuel inflation and also added that the impact of the hike in service tax rates to 14 per cent effected in June will flow into the inflation reading through the year, he said.
On economic growth, Rajan said the outlook is improving gradually and maintained the projection at 7.6 per cent for FY16.
He, however, warned that the contraction in exports could become a prolonged drag on growth going forward.
He said the global economic activity has recovered modestly in the June quarter.
A majority of analysts and RBI watchers were expecting the Reserve Bank to go in for a status quo at the policy meet given the late surge in inflation.
The consumer price inflation accelerated to 5.4 per cent for June from the 5.01 per cent in the preceding month on rising food prices.
The acceleration in inflation came despite a favourable base effect.
The RBI has cut its key rates thrice this year, in January, March (both off-policy moves), and during the June policy.
Under a target declared as part of a newly announced inflation-targeting framework, RBI is targeting to hold the inflation under 6 per cent by January next year, which many analysts feel is possible.
However, after this, the central bank's aim is to compress it down further to 4 per cent in two years.
Recently, there have been some supporting factors like better-than-expected rainfall, wider acreage of sown crop and a softness in global commodity prices following the Iran nuclear deal which may take off the pressure on inflation.
Those making a case for rate cuts had been hoping that these factors, along with the sluggish economic growth, will prevail upon the central bank to ease the rates further.
The factory output growth slowed down to 2.7 per cent in May from 3.4 per cent in the previous month.