RBI maintains status quo on policy rates

CPI inflation projection retained at 5% by March 2017, while GDP growth projection also retained at 7.6% for FY2017

In its third bi-monthly monetary policy review, the Reserve Bank of India (RBI) has maintained status quo on key policy rates. The policy repo rate under the liquidity adjustment facility (LAF) is kept unchanged at 6.5%, while the cash reserve ratio (CRR) of scheduled banks is also left unchanged at 4.0% of net demand and time liabilities (NDTL).

As per the RBI, since the second bi-monthly statement of June 2016, several developments have clouded the outlook for the global economy. World trade remains sluggish in the first half of 2016. Yields on government bonds have fallen further and the universe of negative yielding assets is expanding at a fast pace, reflecting high risk aversion and expectations of further monetary accommodation by systemic central banks. Crude prices, which had risen to an intra-year high in May on supply disruptions, remain volatile. Other commodity prices, barring those of precious metals, remain soft due to weak demand.

On the domestic front, RBI believes that several factors are helping to support the recovery. After a delayed onset, the south west monsoon picked up vigorously from the third week of June. Industrial production picked up in May on the back of manufacturing and mining, following a contraction in the preceding month. There are some signs of green shoots in manufacturing, with purchasing managers and the Reserve Bank's industrial outlook survey indicating a pick-up in new orders, both domestic and external. Business confidence is also looking up in recent months, though the Reserve Bank's survey for March 2016 suggests that capacity utilization, seasonally adjusted, is still weak.

Service sector purchasing managers polled the thirteenth successive month of expansion in July on the basis of a sharp acceleration in new business. Business expectations remained optimistic on better economic conditions and planned increases in marketing budgets.

Retail inflation measured by the headline consumer price index (CPI) rose to a 22-month high in June, with a sharp pick-up in momentum overwhelming favourable base effects.

Liquidity conditions eased significantly during June and July on the back of increased spending by the Government which more than offset the reduction in market liquidity because of higher-than-usual currency demand.

In the external sector, merchandise export growth moved into positive territory in June after eighteen months. Cumulatively, the trade deficit narrowed in Q1 of 2016-17 on a year-on-year basis. Net receipts on account of services remained flat in April-May 2016, with net outflow under communication services and sluggish software earnings. While the pace of foreign direct investment inflows slowed in the first two months of 2016-17, net portfolio flows were stronger after the Brexit vote, notwithstanding considerable volatility characterising these flows. The level of foreign exchange reserves rose to US$ 365.7 billion by 05 August 2016.

Policy Stance and Rationale

On balance, inflation projections as given in the June bi-monthly statement, i.e. of a central trajectory towards 5% by March 2017 with risks tilted to the upside, are retained.

The GVA growth projection for 2016-17 is retained at 7.6%, with risks facing the economy at this juncture evenly balanced around it.

Risks to the inflation target of 5% for March 2017 continue to be on the upside. Te RBI has kept the policy repo rate unchanged at this juncture, while awaiting space for policy action. The stance of monetary policy remains accommodative and will continue to emphasise the adequate provision of liquidity. Easy liquidity conditions are already prompting banks to modestly transmit past policy rate cuts through their MCLRs and pro-active liquidity management should facilitate more pass-through.

As regards the management of the imminent FCNR (B) redemptions, the Reserve Bank has been frontloading liquidity provision through open market operations and spot interventions/deliveries of forward purchases. The Reserve Bank will continue with both domestic liquidity operations and foreign exchange interventions that should also enable management of the FCNR (B) redemptions without market disruptions.

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