RBI Maintains Status Quo on Interest Rates: Key Takeaways for India

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 7^th 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.