The Reserve Bank of
India, in its bi-monthly monetary policy statement, kept the policy rate (i.e.
repo rate), cash reserve ratio (CRR) and statutory liquidity ratio (SLR) unchanged
at 6.75%, 4% and 21.5% respectively because of the elevated household
inflationary expectations in the economy. The central bank also cited rising
staff costs in the corporate sector and pay outs on account of 7th
Central Pay Commission (CPC) as factors that could impart upward momentum to the
inflation trajectory.
Though, lack of rate cut
was in line with expectations, RBI was perhaps a shade unrelenting on liquidity,
given that current shortfall in liquidity is roughly to the tune of Rs 1.5 lakh
crore. Liquidity conditions tightened starting December because of seasonal
pick-up in demand for currency, restrained spending by the government and pick
up in bank credit growth. However, Governor’s assurance that the RBI will keep
call rates close to repo and will deploy all possible tools to manage the
liquidity deficit means that liquidity conditions should start to ease around
April.
As far as retails
inflation (i.e. CPI) is concerned, it rose for fifth straight month in December
2015, largely on account of double digit up-tick in prices of pulses and because
of sticky prices of services such as housing, transport and medical. Nevertheless,
inflation for the current fiscal year has evolved closely along the trajectory
set by the RBI, thanks to effective supply management for cereals by the
government and benign prices of fruits, vegetables and more importantly crude.
Consequently, the
central bank expects that the target of 6% inflation for January 2016 will be
met and going forward, with likelihood of normal monsoon and moderate crude
prices this year, it expects inflation to be ~5% by the end of FY17. At the
same time, it has cautioned that spatial and temporal distribution of monsoon
and impact of adverse geopolitical developments on commodity and financial
markets could add to uncertainties.
The statement further
added that RBI was still ‘accommodative’ but would watch out for the Union
Budget for FY17, which ought to support growth and check spending if it has to
create more space for monetary easing. It was of view that domestic economic
activity will strengthen, but gradually, as there are number of headwinds
arising due to subdued global output and trade growth. The minor recovery in
U.S and Euro Area on account of improved labour market conditions have been
outweighed ongoing deceleration in many emerging markets (EMs) and Japan. And
uncertainties around the Chinese economy and Renminbi depreciation have only
triggering EM sell-off and heightening volatility.
It was, therefore, not
surprising that domestic economic activity lost momentum in Q3 of FY16 (growth
was pulled down by slackening global as well as internal factors (i.e. muted
agricultural, construction and private investments along with dampened
exports). India’s exports remained in contraction mode for thirteenth
successive month in December, and if not for softer commodity prices, overall
current account was unlikely to be well contained at 1.6% for Q2 FY16. The
persistent decline in oil prices is also likely to hit remittances from the
gulf along with portfolio investments by Sovereign Wealth Funds (SWFs).
Notwithstanding headwinds, pick-up in road sector, industrial corridors and new
business orders along with expectations of good monsoon bodes well for future activity.
Thus, on balance, RBI projects growth to around ~7.4% in FY16 and around ~7.6%
in FY17.
To sum up, the current
momentum of growth, though sub-optimal, is reasonable under the current global
scenario. A continued thrust on rekindling growth drivers such as increase in
public investment, structural reforms and in particular revival of private
investment and rural economy will place the economy durably on a higher growth
trajectory.
