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Risks to inflation target balanced for now

The Reserve Bank of India sounded relaxed on inflation which commented that the risks are balanced with expectation that the new government will act on resolving supply side bottlenecks and will improve the fiscal position.

As a result, the 8% forecast of retail inflation by January looks achievable.

“The risks to the central forecast of 8% CPI inflation by January 2015 remain broadly balanced,” the central bank said today while announcing its bi-monthly monetary policy review.

The favourable conditions gave hope to the market participants that the status quo will be maintained for some more time. However, risks to inflation could emerge later and the central bank will resume its hawkish stance once again.

“The decision to hold rates reflects the current level of inflation as well as the expectation of policy and administrative actions from the government in the coming months to address inflation as well as boost growth,” said Chanda Kochhar, managing director and chief executive officer of ICICI Bank.

According to market participnats, the bigger challenge for the central bank would be to achieve 6% inflation by January 2016.

“We see a few risks lurking in the background. These may lead to price pressures remaining sticky into year-end and could yet force the hand of the RBI to raise interest rates one more time. Note that officials reiterated their target of bringing headline CPI inflation to 8% in January and 6% by early 2016. Amid all the dovish talk, therefore, the commitment to price stability remains,”  HSBC said in a note to its clients.

That the central bank will continue its vigil on inflation, despite a ‘mildly dovish’ statement, is also evident from the fact that it is gradually shifting towards term repo for lending to banks rather than the one day repo. In addition, it has reduced the cap on export credit refinance to 32% from 50% of eligible export credit outstanding, as recommended by the Urjit Patel committee, which was set up to review the monetary policy.

“To move away from sector-specific refinance towards a more generalised provision of system liquidity without preferential access to any particular sector or entity, RBI has decided to limit access to export credit refinance while compensating fully with a commensurate expansion of the market’s access to liquidity through a special term repo facility,” the central bank said.
The move, according to bankers, will increase their cost of funds.

“RBI is slowly pushing banks towards better management of treasuries and pushing us to borrow term repo rather than borrow in the one day window. Cost of funds will go by a little bit up for those accessing this window,” said Arundhati Bhattacharya, chairman, State Bank of India.

P Sitaram, Chief Financial Officer at IDBI bank also agreed that the cost of funds will go up with RBI to borrow from a longer term window rather than an overnight one.

“The cost of funds may go up but it is difficult to say by what exactly would be the impact as it will depend on liquidity needs. We will also see how much we end up using this window and depending on all these factors we will have to take a call on how to address the rising cost of fund issue.”

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