As we expected, the central bank maintained status-quo on policy rates, keeping repo rates at 7.5% and cash reserve ratio at 4%. Lack of policy rate transmission and the possibility that incoming data will provide more clarity on the balance of risks on inflation, the Reserve Bank decided maintain status quo in its monetary policy stance in this review.
The central bank also decided to:
- Continue to provide liquidity under overnight repos at 0.25% of bank-wise NDTL (net time and demand liabilities) at the repo rate and liquidity under 7-day and 14-day term repos of up to 0.75% of NDTL of the banking system through auctions and
- continue with daily variable rate repos and reverse repos to smooth liquidity.
Source: Reserve Bank of India
The RBI sees inflation at 5.8% by March 2016. Reading this along with real policy rate target of 1.5%-2%, this could mean a rate cut of another 25bps in the next 12 months.
Source: Reserve Bank of India, MOSPI
Other key takeaways from the policy statement are outlined below:
RBI expects CPI inflation at its current levels (5%-6%) in the Apr-Jun 2015 quarter, moderating thereafter to ~4% by August but firming up to reach 5.8% (mid-point of estimate) by March 2016. Upside risks to inflation are:
- Possible intensification of el niño conditions leading to a less than normal monsoon - this could lead to higher food inflation,
- large deviations in vegetable and fruit prices from their regular seasonal patterns, given unseasonal rains (heavy unseasonal rains in March destroyed crops in northern and eastern India),
- larger than anticipated administered price revisions (minimum support prices for crops fixed by the government),
- faster closing of the output gap,
- geopolitical developments leading to hardening of global commodity prices (mainly crude oil) and
- spillover from external developments through exchange rate and asset price channels.
Source: Reserve Bank of India projections
The bank also believes that, as of now, these upside risks appear to be offset by downsides originating from:
- Global deflationary/disinflationary tendencies,
- the still soft outlook on global commodity prices - especially crude oil which remains around USD 55-60 per barrel and
- slack in the domestic economy.
Transmission of policy rates
Transmission of policy rates to bank lending rates to customers has not taken place so far, despite weak credit off-take and the front loading of two rate cuts. Lack of policy rate transmission is one of the two major reasons cited by the RBI as justification for maintaining status quo.
Monetary Policy Framework
- The central bank stated that the Monetary Policy Framework Agreement signed by the Government of India and RBI in Feb. 2015 will shape the stance of monetary policy going forward.
- The Reserve Bank will stay focused on ensuring that the economy dis-inflates gradually and durably, with CPI inflation targeted at 6% by Jan. 2016 and at 4% by Mar. 2018 (with tolerance band of +/- 2%).
- RBI believes that the outlook for growth is improving gradually.
- Comfortable liquidity conditions should enable banks to transmit the recent reductions in the policy rate into their lending rates, thereby improving financing conditions for the productive sectors of the economy.
- Along with initiatives announced in the Union Budget to boost investment in infrastructure and to improve the business environment, these factors should provide confidence to private investment and, together with the conducive outlook on inflation, deliver real income gains to consumers and lower input cost advantages to corporates.
- RBI believes that, though GDP growth estimates by India's Central Statistical Office for 2014-15 (Apr-Mar) project a robust pick-up, it believes that leading and coincident indicators suggest a downward revision of these estimates when fuller information on real activity for the Jan-Mar quarter becomes available.
- Uncertainty surrounding the arrival and distribution of the monsoon rains and unanticipated global developments are the two major risks to baseline growth projections. Assuming a normal monsoon, continuation of the cyclical upturn in a supportive policy environment, and no major structural change or supply shocks, output growth for 2015-16 is projected at 7.8%, higher by 30 bps from 7.5% in 2014-15, but with a downward bias to reflect the still subdued indicators of economic activity.
Source: Reserve Bank of India projections
Guidance on policy stance
The bank stated that, going forward, the accommodative stance of monetary policy will be maintained, but monetary policy actions will be conditioned by incoming data as mentioned below:
- Transmission by banks of its front-loaded rate reductions of 50bps in the first quarter of 2015 into lending rates to customers.
- Developments in sectoral prices, especially those of food, as well as the effects of recent weather disturbances and the likely strength of the monsoon rains, as the Reserve Bank stays vigilant to any threats to the disinflation that is underway. RBI will also look through both seasonal as well as base effects.
- Continuation and even acceleration of government's policy efforts to unclog the supply response so as to make available key inputs such as power and land. Further progress on re-purposing of public spending from poorly targeted subsidies towards public investment and on reducing the pipeline of stalled investment will also be helpful in containing supply constraints and creating room for monetary accommodation.
- Signs of normalization of the US monetary policy, though RBI anticipates India is better buffered against likely volatility than in the past.
The current pause on policy rates was as expected, and the policy stance does not differ from its previous monetary policy statement in March 2015. Our base case for policy rate cut is 25bps, while 50bps cut is optimistic. We expect the next rate cut to happen only in June 2015 or later. The next bi-monthly policy meeting will happen on June 2nd.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.