Monetary Policy – April 2015

Monetary Policy – April 2015
In its maiden policy announcement of FY16, the Reserve Bank of India kept the key policy rate i.e. the
repo rate unchanged at 7.5% putting a pause to the two rate cuts earlier in 2015 (both were out of the
policy cycle). This is in line with CARE’s forecast of a status quo on the repo rate. In the policy
announcement, the RBI has seemingly put forward further preconditions before taking action on easing
its stance any further.
April 7, 2015
Policy repo rate under the Liquidity Adjustment Facility (LAF) is held constant at 7.5%.
Therefore, reverse repo stands unmoved 100 bps lower than the repo rate at 6.5% while the
Marginal Standing Facility (MSF) rate remains 100 bps higher than the repo rate at 8.5%.
Cash Reserve Ratio (CRR) of scheduled banks is also unchanged at 4% of NDTL
Liquidity front
 Continue providing liquidity under the overnight repos at 0.25% of bank wise NDTL at the LAF
repo rate and through the 7-day and 14-day term repos of up to 0.75% of NDTL of the banking
system through auctions.
 Continuation of daily variable rate repo and reverse repo auctions to foster the smooth
management of liquidity.
Macroeconomic Backdrop
Global Assessment: Global growth is picking momentum in 2015 so far relative to the previous
year. GDP growth continues to strengthen in the USA; however Q1 2015 is expected to record a
muted growth. Growth has firmed marginally in the Euro area as also Japan where exports have
also recorded improvement. However, China remains a weak link with the country’s officials
recognizing that it is off its peak growth phase. Additionally, monetary policies across advanced
economies such as USA, Euro zone, Canada, Japan, and emerging economies such as China,
Indonesia, Thailand, South Korea etc are in an easing cycle in order to provide a fillip to economic
growth. As regards financial markets, strong foreign inflows particularly into emerging economies
with a stronger fundamental remain high thereby creating a risk of major outflow and dent in the
financial markets when the monetary cycle in the USA begins to turn around.
Domestic Economy:
o Growth: Growth in the domestic economy has strengthened from a year ago levels with the
GDP estimate of 7.4% for FY15 as against 6.9% in FY14. This stronger growth is expected to be
supported by the primary and secondary sectors of the economy as food production is viewed
to be higher than the weak outlook for the same at the start of FY15. The positive IIP growth for
the last three consecutive months implies a revival in industry and in particular the
manufacturing sector.
o Inflation: Throughout fiscal ’15, RBI maintained a razor sharp focus on the Consumer Price
Inflation (CPI) and strived towards following the ‘disinflationary glide path’ put forward by the
Dr. Urjit Patel Committee report in Dec ’13. However, inflation has receded considerably since
then. CPI inflation was well within RBI’s target as of Feb ’15 at 5.3% despite the reversal of the
high base effect. At the wholesale level, inflation entered negative territory at -2.1% in Feb ’15.
o Liquidity: Liquidity management has been proactively carried out through the various term repo
auctions by the RBI. This has ensured a smooth flow and availability of sufficient liquidity in the
o Trade: Export growth is muted currently primarily on account of the relatively stronger INR visà-vis the USD which has impacted the country’s export margins. However, a strong export of
services in software and travel has contributed towards a lower Current Account Balance of
1.6% of GDP in Q3 FY151. Although foreign inflows have moderated marginally, they remain on
the higher end. Thus the strong foreign inflows into domestic equity, debt securities and by way
of FDI have implied an enhancement to the country’s Foreign Exchange Reserves.
Policy Rationale
After inflation being the prime determinant of the RBI policy, the focus has now shifted to the monetary
transmission mechanism. Thereby, policy rationale for the status quo position on the policy rate emanates from
the weak transmission channel of the monetary policy despite a low credit off take throughout FY15.
 Transmission Mechanism: Notwithstanding the two rate cuts exercised earlier in 2015, the same has not
transpired into a contemporaneous cut in bank lending rates. Thus, improvement in the transmission
mechanism appears to be an underlying precondition to any further action on the interest rates. On the
same note, there is an expectation that comfortable liquidity conditions in the system will enable banks to
exercise a reduction in their lending rates. As a step towards improving the transmission mechanism, the
RBI has introduced ‘marginal-cost-of-funds-based’ determination of the Base rates of Banks. However,
given that Banks would have to consider their average cost of portfolio practically, it remains to be seen if
the marginal cost pricing method would work effectively.
 The RBI is also cognizant of the low credit off-take compared with year ago levels.
 While recognizing that CPI inflation has traversed the envisaged path and was in fact considerably under
the target range for Jan ’15, there remain certain threats to price stability going ahead. There remains
uncertainty over the monsoon in FY16 as gauged by the unseasonal rains already recorded in parts of the
country. This is likely to cause a sizeable deviation of vegetable and fruit prices from their seasonal
average. Further, volatility in global geo-political space is bound to have ramifications on commodity
prices as also exchange rate.
Note, the new GDP series would have also provided some cushion to CAD for Q3 FY15
Monetary Policy – April ‘15
There is also a sense that RBI is conscious of the impending rate hike in the USA and its immediate impact
on domestic financial markets, foreign exchange reserves and the linked chain reaction on exchange rate,
trade and current account balance.
Hence, providing a cushion against any untoward developments and to await further data to better assess
the domestic economic health appear to be the distinct rationale behind the status-quo position in the
repo rate.
RBI’s Macro Outlook
RBI expects there to be a modest pick-up in GDP growth in FY16 supported by the Government’s thrust on
infrastructure, a stable inflationary outlook and improving business environment with an increase in
private investment. Thereby, the RBI holds a conservative forecast for GDP growth at 7.8% in FY16
compared with 7.4% in FY152.
The RBI expects consumer inflation to prevail near existing levels for Q1 FY16, soften in Q2 to reach around
4% in Aug ’15 and then increase to 5.8% by Mar ’16.
Going ahead, the RBI has stated that its preconditions on further policy easing would emanate from the
developments in the transmission channel of the monetary policy (lending rate cuts by Banks), movement
in food prices and progress of monsoon. Lastly, although the Indian economy stands in better light than
the last instance, RBI would closely monitor signs of monetary policy normalization in the USA.
CARE’s View
Overall, RBI’s first bi-monthly credit policy has been largely in line with CARE’s expectations.
 We retain our expectation of a GDP growth of 8% in FY16 contingent on a normal monsoon and absence
of any untoward shock.
 While, we still foresee a 50 basis points cut in the repo rate in FY16, the same is unlikely to be seen till
June ’15.
 Thus, the 10 year government security paper is viewed to remain around 7.7% until any action on interest
rate is taken by the RBI.
A downward revision is anticipated in GDP growth for FY15
Monetary Policy – April ‘15
Madan Sabnavis
Chief Economist
[email protected]
Garima Mehta
Associate Economist
[email protected]
This report is prepared by the Economics Division of Credit Analysis &Research Limited [CARE]. CARE has taken utmost care to ensure accuracy and
objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of
information contained in this report is guaranteed. CARE is not responsible for any errors or omissions in analysis/inferences/views or for results
obtained from the use of information contained in this report and especially states that CARE (including all divisions) has no financial liability
whatsoever to the user of this report.
Monetary Policy – April ‘15