5 key takeaways from RBI's Monetary Policy review

Over the last fortnight, the clamour for a 50bps rate cut grew stronger, with the RBI cutting rates on small savings instruments

As widely expected, the Reserve Bank of India (RBI) cut the repo rate – the rate at which the banks borrow from the central bank – by 25 basis points (bps) to 6.5%. This is the first time that the central bank has cut rate in the last six months (last rate cut was 25 bps in September 2015), and also the first in financial year 2016 – 17 (FY17).

Over the last fortnight, the clamour for 50bps rate cut grew stronger, with the central bank lowering rate on small savings instruments like the Public Provident Fund (PPF), Senior Citizen Savings Scheme (SCSS) etc. 

 

“The RBI rate reduction was as expected but its measures on liquidity is an attempt to improve and speed up the transmission. Its move to bring system liquidity to neutral along with the narrowing of the corridor to 50 bps and CRR maintenance at 90% will allow overnight rates to remain very close to the Repo rate or even drift marginally lower. We expect proactive open market operations (OMOs) to get the 'core' liquidity deficit back to zero," said Murthy Nagarajan, head of fixed income at Quantum AMC.

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“As expected RBI delivered 25bps of repo rate cut. With the growth-inflation outlook remaining benign we maintain our view of another 25bps of repo rate cut this year. More positively, the MSF cut by 75bp along with the liquidity easing measures especially the reduction of minimum daily CRR maintenance should help money market rates ease significantly. Further, additional OMO purchases should provide the much needed relief to the bond markets," adds Upasna Bhardwaj, economist, Kotak Mahindra Bank.

Here are a few key takeaways from the policy:

Focus on liquidity and transmission of rate cuts: One of the key areas the policy focuses on is the transmission of the earlier and the current cut in interest rates. The central bank cut the minimum daily maintenance of the cash reserve ratio (CRR) from 95% of the requirement to 90% with effect from the fortnight beginning April 16, 2016, while keeping the CRR unchanged at 4% of net demand and time liabilities (NDTL).

“More important at this juncture is to ensure that current and past policy rate cuts transmit to lending rates. The reduction in small savings rates announced in March 2016, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut,” the policy statement said.

Eye on inflation and 7th Pay Commission recommendations: The central bank continues to keep an eye on inflation. The central bank believes that the underlying inflation momentum is unlikely to be helped by the 7th Pay Commission award and the effects of the one-rank-one-pension (OROP) award, or by the cost-push effect of the increase in the service tax rate.

Though the RBI expects the Consumer Price Inflation (CPI) to decelerate and remain around 5% during 2016-17 with small inter-quarter variations, it cautious against uncertainties surrounding this inflation path that could emanate from recent unseasonal rains, the likely spatial and temporal distribution of monsoon, the low reservoir levels by historical averages, and the strength of the recent upturn in commodity prices, especially oil.

Economic growth pegged at 7.6%: Economic growth for FY17 measured in terms of Gross Value Added (GVA) has been pegged at 7.6%.

The central bank assumes a normal monsoon this year and sees a consumption boost from the implementation of the 7th Pay Commission recommendations and One Rank One Pension (OROP), it remains cognizant of the fading impact of lower input costs on value addition in manufacturing, persisting corporate sector stress and risk aversion in the banking system, and the weaker global growth and trade outlook. This, the RBI believes, could impart a downside to growth outcomes going forward.

Maintains accommodative stance: The RBI maintained a dovish stance and plans to remain accommodative as far as future rate cuts are concerned. 

"The GVA growth projection for 2016-17 has been retained at 7.6%, with risks evenly balanced around it. The stance of monetary policy will remain accommodative. The Reserve Bank will continue to watch macroeconomic and financial developments in the months ahead with a view to responding with further policy action as space opens up," the RBI statement said.

"We continue to believe that although there is room for another 25bps rate cut, the RBI is likely to rather wait until at least August for further developments on monsoon, 7CPC implementation, core inflation and transmission before cutting rates further. The monetary policy tools that the RBI will use in FY17 is likely change from more policy rate cuts to better liquidity management and improved transmission of the 150bps repo rate cuts already undertaken since the beginning of the cycle," points out Jay Shankar, chief India economist and director at Religare Capital Markets.

Bank’s balance sheet clean-up:  In an attempt to clean up banks’ balance sheets by March 2017, the RBI had asked banks to make additional provisions for corporate loans to sustain potential loan defaults. The central bank is satisfied with the progress made thus far.

"Finally, the process of cleaning up banks' balance sheets is well underway and I am happy with the progress made thus far,” the RBI governor said.