RBI releases fourth Bi-monthly Monetary Policy Statement, 2016-17

The Reserve Bank of India (RBI) on 4 October 2016 released the fourth Bi-Monthly Monetary Policy Statement 2016-17. The key announcement under the policy was the interest cut of 25 basis points. This move may lead to banks in lowering EMIs for housing, car loan and corporate borrowers.This policy decision was not only RBI Governor Urjit Patel’s maiden policy announcement but was also

the first to be announced by the newly constituted Monetary Policy Committee (MPC). All the six members of MPC unanimously decided to cut repo rate by 0.25 per cent; bring in to a nearly six-year low of 6.25 per cent. This was also the first interest rate cut in last six months.

September CA eBook

According to the monetary policy statement, the decision to cut interest rates is consistent with the aim of achieving a midterm inflation target of 4 percent within a band of plus or minus 2 percent.

Based on the assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) decided to:

• Repo Rate: The policy repo rate under the liquidity adjustment facility (LAF) was reduced by 25 basis points from 6.5 per cent to 6.25 per cent with immediate effect.

• Reverse Repo Rate: The reverse repo rate under the LAF stands adjusted to 5.75 per cent.

• Marginal standing facility (MSF) Rate: The MSF rate was fixed at 6.75 per cent.

• Bank Rate: The Bank Rate also stands at 6.75 per cent.

The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth. The main considerations underlying the decision are set out in the statement below.

Assessment of the Economy

• Global growth has been slowing more than anticipated through 2016 so far, with weak investment and trade damping aggregate demand.

• Risks in the form of BREXIT, banking stress in Europe, rebalancing of debt-fuelled growth in China, rising protectionism and diminishing confidence in monetary policy have slanted the outlook to the downside.

• World trade volume has contracted sharper than expected in the first half of 2016, and the outlook has worsened with the recent falling off of imports by Advanced Economies (AEs) from Emerging Market Economies (EMEs). Inflation remains subdued in AEs and has started to edge down in EMEs.

• International financial markets were overwhelmed by the BREXIT vote in Q2, with equity markets losing valuations worldwide, currencies plunging and turning volatile, and investors rushing for safe havens. Markets, however, recovered quickly and reclaimed lost ground in Q3, with a return of risk appetite propelling capital flows back into EMEs.

• Crude prices rose to a recent peak in Q2 of 2016, mostly on supply disruption in various parts of the world, and again in late September as the OPEC announced intentions of cutting back on supply; but, the upturn has been curbed by higher inventories.

Assessment on the domestic front

• Agriculture: The outlook for agricultural activity has brightened as the South West monsoon ended the season with a cumulative deficit of only 3 per cent below the long period average, with 85 per cent of the country’s geographical area having received normal to excess precipitation.

• Kharif: Kharif sowing has surpassed last year’s acreage, barring cotton, sugarcane and jute and mesta. Accordingly, the first advance 2 estimates of kharif food grains production for 2016-17 by the Ministry of Agriculture have been placed at a record level, and higher than the target set for the year.

• Industrial sector: The industrial sector, by contrast, suffered a manufacturing-driven contraction in early fiscal year Q2, after a sequential deceleration in gross value added in Q1. Even after trimming the statistical effects of the lumpy and order-driven contraction of insulated rubber cables, industrial production as measured by the index of industrial production (IIP) turned out to be slower than a year ago.

• Steel: In August, steel production rose to a 37-month high and cement production maintained momentum - auguring well for construction activity - even though the output of core industries as a whole was weighed down by a decline in the production of coal, crude oil and natural gas and deceleration in refinery products and electricity generation.

Nonetheless, business expectations polled in the Reserve Bank’s industrial outlook survey and by other agencies remain expansionary in Q2 and Q3.

• Roads, Railways And Inland Waterways: The strong public investment in roads, railways and inland waterways, the recent efforts to unclog cash flows in large projects under arbitration, and the boost to spending from the 7th Pay Commission’s award, should improve the industrial outlook.

• Services Sector: The acceleration in the pace of activity in Q1 appears to have been sustained. An increasing number of high frequency indicators are moving into positive territory, construction is boosted by policy initiatives, and public administration, defence and other services will be supported by the pay commission award.

• Retail inflation: Measured by the headline CPI had been elevated by a sharp pick-up in the momentum of food inflation overwhelming favourable base effects during April-July. In August, however, the momentum of food inflation turned negative and surprised expectations; consequently, base effects in that month came into full play and pulled down headline inflation to an intra-year low. Fuel inflation has moderated steadily through the year so far. Inflation excluding food and fuel (including petrol and diesel embedded in transportation) has been sticky around 5 per cent, mainly in respect to education, medical and personal care services.

• Liquidity conditions: It remained comfortable in Q3, with the Reserve Bank absorbing liquidity on a net basis through variable rate reverse repo auctions of varying tenors. Liquidity was injected through open market purchases of 200 billion rupees in line with the system’s requirements. As a result, the Weighted Average Call Money Rate (WACR) remained tightly aligned with the policy repo rate and, in fact, traded with a soft bias. Interest rates on commercial paper (CPs) and certificates of deposit (CD) also eased.

• External Sector: Merchandise exports contracted in the first two months of Q2. Subdued domestic demand was, however, reflected in a faster contraction in imports. Moreover, the still soft crude prices pared off a fifth of the oil import bill and gold import volume slumped to a fifth of its volume a year ago. As a result of the same, the merchandise trade deficit narrowed by 10 billion US dollars in April-August on a year-on-year basis.

• Foreign Direct Investment: The pace of foreign direct investment slowed compared to a year ago, portfolio flows were stronger after the BREXIT vote, galvanised by a search for returns in an expanding universe of negative yields. The level of foreign exchange reserves rose to 372 billion US dollars by 30 September 2016 – an all-time high.

Outlook

• The food inflation outlook will improved due to strong improvement in sowing, along with supply management measures.

• Sharp drop in inflation reflects a downward shift in the momentum of food inflation, which holds the key to future inflation outcomes, rather than merely the statistical effects of a favourable base effect.

• Government’s measures to curb the food inflation would help in moderating the momentum of food inflation in months ahead.