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.

RBI Keeps Repo Rate Unchanged: Implications and Takeaways

Repo rate unchanged…

The Reserve Bank of India (RBI) today kept the benchmark repo rate unchanged at 7.25% and the cash reserve ratio (CRR) at 4%. However, Governor Rajan kept the hopes of further rate cuts alive later in the year by reintroducing the phrase ‘accommodative stance of monetary policy’ after having dropped it in the June review. The Governor’s indication of lower interest rates comes despite the fact that the central bank’s inflation projection for January 2016 remains unchanged at 6%, though it is lower by 0.2% for the period January to March 2016 due to soft crude oil prices. 

RBI to wait for significant uncertainties to resolve in the coming months….

The central bank was largely expected to maintain a pause in policy move as the retail inflation had crept to a nine-month high of 5.4% in June. Moreover, it is likely to wait for significant uncertainties to resolve in the coming months including full monsoon out-turn and persistence of inflationary pressures, possible Federal Reserve action on interest rate hike, and the consequences of Iran deal on global crude supply and prices. 

But despite inflationary pressures growing sharply in protein-rich food items, RBI stated that several factors could have a ‘significant mitigating influence’ on future inflation numbers such as low crude prices, increase in planting of pulses and oil-seeds, prospects of rainfall in August and September, government's current proactive supply management to contain shocks to food prices and finally its decision to keep increases in minimum support prices at moderate levels. 

Growth forecast for fiscal year 2016 unchanged at 7.6%....

The RBI assesses the growth outlook to be improving gradually and hence retained the growth forecast of 7.6% for the fiscal year ending March 2016. This seems largely based on some signs of improvements in urban consumption, particularly auto sales and a good monsoon that is expected to boost rural output and incomes, and low commodity prices that is likely to lift overall consumption in the economy. 

But the central bank sounded a cautious note on supply constraints and exports. Notwithstanding some improvement in the state of stalled projects, supply constraints continue to be binding and new investment demand emanating from the private sector and the central Government remains subdued. In addition, export contraction could become a prolonged drag on growth going forward in view of sluggishness in the global economy.

Limited transmission of past rate cuts, loan demand to pick up in the third quarter….

The Governor reiterated his message to banks who have been unwilling to reduce lending rates, arguing that since the first rate cut in January, the median base lending rates of commercial banks have fallen by approximately 0.3%, which is a fraction of the 0.75% in rate cut so far. Consequently, the lack of the trickle-down has had limited benefits for the economy. 

At the same time, the RBI recognizes that part of the problem is the vicious cycle of non-performance in industries and the large debt burden it is saddled with, and the rising bad loans in the banking system. Indebted companies, therefore, argue that the central bank should take comfort in the fall in wholesale price inflation for an unprecedented eight months and cut interest rates further, but to no avail. Instead the central bank, expecting loan demand to pick up in the third quarter of current fiscal year, has advised commercial banks to cut lending rates further to secure new lending.

Key takeaways

• The central bank is cognizant of the recent inflationary pressures and has taken into account, both, concerns as well as factors that may potentially offset these concerns. Given that it has reduced its forward inflation forecast, it believes that the prices will soften in coming months.

• The RBI also stated that it will monitor developments to identify emerging room for further monetary easing. Therefore, taking into account RBI’s comfort range on real rates at 1.5-2% and the mitigating influence of several stated factors are expected to keep CPI inflation below the January 2016 target of 6%, we can expect a further 0.25% easing this fiscal. 

• Though the balanced approach and dashing of expectations with respect to an imminent hike in foreign investment limits did not cheer the market, the rupee strengthened in the intra-day trading against the dollar. The RBI and government are believed to be working on an institutional framework wherein limits will be increased by a quantum based on foreign investors’ share in the market and the setting is expected to happen twice a year. The Governor’s statement that the next round of limit review will factor in potential volatility around Fed and domestic liquidity (i.e. during October-December) has poured cold water on market’s expectation. 

• The RBI's next policy review is set for September 29, after the Fed’s meeting. The market expects that an increase in US interest rate will suck money out of emerging markets. Not surprising that the central bank has decided to maintain a status quo to gauge the potential impact and volatility in the foreign exchange market before finalizing its own stance.