Mumbai: The Reserve Bank of India (RBI) has hit the pause button on interest rate cuts. With inflation showing signs of picking up, the central bank chose to keep policy rates unchanged on Tuesday and said it would wait for uncertainty on rains and commodity prices to clear up before it decided to cut rates further.

RBI’s stance remains “accommodative", the central bank said in a statement, but most economists don’t expect a rate cut at least until August. Room for rate cuts, if any, will be restricted to another quarter percentage point, they add.

“Given the uncertainties, the Reserve Bank will stay on hold, but the stance of monetary policy remains accommodative. The Reserve Bank will monitor macroeconomic and financial developments for any further scope for policy action," RBI said in its statement.

On Tuesday, RBI left its benchmark rate unchanged at 6.5% and the cash reserve ratio (which defines the portion of their deposits banks have to hold with the central bank) at 4%. RBI has cut its benchmark rate by 150 basis points since the start of 2015.

It was clear from the central bank’s statement that it sees upside risks to its objective of bringing down inflation to 5% by March 2017.

Concerns over inflation have resurfaced ever since consumer price inflation rose to 5.4% in April. Wholesale price index (WPI) inflation swung into positive territory in April after being negative for six quarters, indicating that some pricing power may be returning. Brent crude prices have also risen 33% since RBI’s April policy.

“The inflation surprise in the April reading makes the future trajectory of inflation somewhat more uncertain," RBI said in its statement. “... there are upside risks—firming international commodity prices, particularly of crude oil; the implementation of the 7th Central Pay Commission awards which will have to be factored into projections as soon as clarity on implementation emerges; the upturn in inflation expectations of households and of corporates; and the stickiness in inflation excluding food and fuel."

The central bank, however, added that a normal monsoon and the introduction of an electronic national agricultural market should prevent flare-ups in food inflation.

RBI’s survey of professional forecasters pointed to a reasonable probability that retail inflation may overshoot the central bank’s 5% target for March 2017. Forecasters assigned the highest probability of 49% for average inflation to be 5-5.9% during fiscal 2017.

This could mean that RBI is done with rate cuts for now.

“Our baseline forecast calls for policy rates to stay on hold for the foreseeable future and today’s policy statement acknowledging upside risks to inflation should re-inforce that view. That said, we cannot completely rule out one final rate cut in the cycle but the bar for that has increased over the last two months on the back of firming food and oil prices, and sticky core inflation," wrote Sajjid Chinoy, chief India economist at JP Morgan India, in a note on Tuesday.

Siddhartha Sanyal, chief India economist at Barclays Bank, agrees.

“A cut in Q3 2016 remains our baseline scenario. However, we recognize a non-negligible risk of a rate cut taking place later, possibly in Q4 2016—the precise timing of a further rate cut will depend on a host of factors including the unfolding inflation trajectory, commodity prices, global financial market developments and potentially even the decision on the reappointment of the RBI governor," he said in an emailed response.

The good news is that RBI sees demand conditions in the economy improving.

“The Reserve Bank’s latest rounds of forward-looking surveys indicate an improvement in the overall business situation, driven by a pickup in capacity utilization and in order books—both domestic and external. These developments have improved the expectation of business conditions in the first half of 2016-17," said RBI.

“Demand conditions are likely to improve going forward; consumer confidence is seen rising on improving expectations of employment and spending, with rural demand aided by a stronger monsoon. Rising capacity utilization should prompt private investment," it added.

Gross domestic product (GDP) data released on 31 May showed that the economy grew at a faster-than-expected 7.9% in the final quarter of fiscal 2016.

RBI did not make any changes in its liquidity stance on Tuesday. In the April policy, it had said that it would move towards neutral liquidity, which will help improve the transmission of previous rate cuts. It continues to bank on that.

“More monetary transmission to support the revival of growth continues to be critical. The government’s reform measures on small savings rates combined with the Reserve Bank’s refinements in the liquidity management framework should help the transmission of past policy rate reductions into lending rates of banks," it said, adding that timely capital infusions into constrained public sector banks will also aid credit flow.

The central bank has so far infused close to 70,000 crore through bond purchases in the banking system in the process of bringing liquidity to neutral levels.

Bankers are uncertain if they will be able to bring down lending rates.

“RBI’s stance during this policy has certainly been slightly hawkish. We were anyway not expecting any cuts in interest rates today. If inflation persists and the rates in the system are high, then the headroom for banks to cut their rates would be very small. We may not see much reduction in rates then," said Ashwani Kumar, chairman of Dena Bank.

In an emailed comment, Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd, said the assurance that the central bank is moving towards neutral liquidity is positive.

“This should continue to support transmission of RBI’s policy stance," said Kochhar, whose bank cut its marginal cost lending rate by 5 basis points earlier this month.

The redemption of foreign currency non-resident (FCNR) deposits raised by banks in 2013 could lead to outflows to the tune of about $20 billion, Rajan told reporters in the press meeting after the monetary policy. RBI will provide dollar and rupee liquidity, if needed, to prevent any disruptions in the market.

“To the extent that people have borrowed to invest in FCNR deposits, that leveraged portion may not be renewed. Therefore, there could be outflows of the order of $20 billion or so," said RBI governor Raghuram Rajan. RBI has covered these outflows in the forwards market and will take advance deliveries of these forward positions in the lead-up to the maturity of these deposits.

In September 2013 when the rupee was under pressure, banks raised $25 billion through FCNR deposits and another $9 billion through foreign currency borrowings and swapped the same with RBI. It is this $25 billion chunk, most of which was linked to borrowed funds, that will be due between September and November.

While RBI said that it is prepared, it acknowledged that volatility may emerge, as some banks may not be able to easily deliver the dollars that they owe to RBI. The outflows may also lead to some broad dollar shortage in the markets.

“This is something we will monitor. We will supply dollars in case of extreme volatility but no one should take this for granted. But for sure we have plenty of dollars that we can supply if necessary," said Rajan.

RBI will have to stay vigilant between the months of September and November, when most of these deposits mature, say experts.

“There will be impact on multiple fronts when FCNR deposits mature. There could be a spike in dollar/rupee. There would be a balance sheet effect as deposits mature. Also the impact on dollar and rupee liquidity cannot be ruled out. All these have to be taken care of," said Ananth Narayan G., regional head of financial markets for Asean and South Asia at Standard Chartered Bank.

RBI, however, is drawing comfort from the fact that its foreign exchange reserves now stand at a comfortable $360 billion. As such, it can sell dollars to ease any shortage of foreign exchange. This may lead to a shortage of rupee liquidity as by selling dollars, RBI will suck out rupees from the system. But RBI says it will provide short-term rupee liquidity if needed.

“As far as our ability to act, there should be no question. But we don’t want to encourage complacency on the part of people who have sold us dollars assuming that we will come in if they can’t provide the dollars to us and bail them out. That is not the intent at all," said Rajan.