Third Bi-monthly Monetary Policy Review, 2015-16
Monetary and
Liquidity Measures On the basis of an assessment of the current and
evolving macroeconomic situation, RBI has been decided to:
- keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.25 per cent;
- keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liability (NDTL);
- continue to provide liquidity under overnight repos at 0.25 per cent of bankwise NDTL at the LAF repo rate and liquidity under 14-day term repos as well as longer term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and
- continue with daily variable rate repos and reverse repos to smooth liquidity. Consequently, the reverse repo rate under the LAF will remain unchanged at 6.25 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 8.25 per cent
Third Bi-monthly Monetary Policy Review, 2015-16 for Bank Exams |
2. Since
RBI last statement, global economic activity has recovered modestly in
Q2 of calendar 2015. The US economy rebounded on stronger consumption
growth and steadily improving labour market conditions, though recent
wage data suggest continuing slack. The Euro area has grown at a
moderate pace through the first half of 2015, supported by consumer
spending, easing financing conditions and a modest downturn in
still-high unemployment. In Japan, growth slowed in Q2 after an upside
surprise in Q1. Domestic consumption is still weak, but manufacturing
activity picked up in July and strengthening exports and corporate
profitability could stimulate capital spending in H2. In the emerging
market economies (EMEs), activity decelerated through H1 due to
headwinds from weak external demand, tightening external financing
conditions, deteriorating structural bottlenecks and spill overs from
unsettled conditions in financial markets. Despite aggressive policy
stimuli, the Chinese economy is slowing on macroeconomic rebalancing,
sizable stock market corrections, a cooling property market and excess
capacity in several manufacturing industries. Manufacturing activity
weakened further in July, clouding near-term expectations. Recessionary
conditions persist in both Russia and Brazil, with downside risks from
commodity prices and geopolitical developments casting a shadow on the
outlook, including for other EMEs.
3. In
recent months, financial markets have experienced high turbulence due to
the Greek crisis, the Chinese stock market slump and shifts between
risk-on and riskoff sentiments based on changes in beliefs about when
the Federal Reserve will start raising rates. Bond market sell-offs
originating in Germany lifted bond yields across the world, including in
EMEs, and tightened financing conditions. Equity markets were buoyed by
the search for yields which stretched asset valuations until end-June,
when sharp stock market corrections in China pulled down share prices
globally. Currency markets were dominated by the rising US dollar, which
impacted foreign currency borrowing exposures, increased exchange rate
volatility and also produced sizable capital outflows from EMEs.
Investors have reduced exposures to EMEs as an asset class, but a
generalised flight to safety is yet to be seen. Investors have also
shunned commodities affected by the Chinese slowdown, including
bullion.
4. In
India, the economic recovery is still work in progress. After strong
rainfall in June, July has been below par, but on net, the monsoon is
near normal. Higher reservoir levels also auger well for the prospects
of kharif output, particularly for areas that are dependent on
irrigation. Consequently, kharif sowing has expanded significantly
relative to a year ago, especially in respect of oilseeds, pulses, rice
and coarse cereals. These developments, supported by contingency plans
for vulnerable districts, provide cushion against adverse weather
shocks. If prospects of a good harvest strengthen, currently weak rural
demand will improve to provide an important boost to activity. Shrinking
exports in some industries, in part a result of weak global demand and
global overcapacity in those industries and in part a result of the
significant depreciation of currencies of some major trading partners
against the rupee, also contributed to weak aggregate demand. The
Reserve Bank’s surveybased indicators point to flat capacity utilisation
and new orders, with corporate sales growth declining – although lower
inflation explains some of the compression in top lines. Although
overall business confidence is positive, the level of optimism was a
shade lower in April-June than in the preceding quarter. Investment, as
measured by new projects, is still weak, primarily because of still-low
capacity utilization. In the critically important power sector, where
final demand is strong, the recent step-up in generation in response to
the commendable easing of bottlenecks in coal supply is being partly
negated by structural problems relating to clogging of transmission
grids and the dire financial state of electricity distribution companies
(DISCOMs).
5.
However, there are signs that consumption demand, especially in urban
areas, is picking up. Car sales for July were strong. Nominal bank
credit growth is lower than previous years, but adjusted for lower
inflation as well as for lower borrowing by oil marketing companies and
increased borrowing from commercial paper markets, credit availability
seems to be adequate for most sectors.
6. The
services sector continues to emit mixed signals. The pick-up in heavy
commercial vehicle sales and rising port and domestic air freight in Q1
suggest strengthening transportation activity (for Indian data, Q refers
to fiscal year quarters). Purchasing managers’ indices were in
contraction zone in June, mainly due to lower new and existing business
conditions. Survey-based expectations of the outlook for the services
sector point to positive sentiment in Q2 on the back of an expected
increase in turnover and profit margin.
7. Headline
consumer price index (CPI) inflation rose for the second successive
month in June 2015 to a nine-month high on the back of a broad based
increase in upside pressures, belying consensus expectations. The sharp
month-on-month increase in food and non-food items overwhelmed the
sizable ‘base effect’ in that month. Food inflation rose 60 basis points
over the preceding month, driven by a spike in prices of vegetables,
protein items - especially pulses, meat and milk - and spices.
8. Furthermore,
excluding food and fuel, inflation rose in respect of all subgroups
other than housing. The momentum of price increases remained high for
education. Inflation pressures increased for personal care and effects
and household goods and services sub-groups. Inflation in CPI excluding
food, fuel, petrol and diesel has been rising steadily since April and
exceeded headline inflation through Q1. Near-term inflation expectations
of households returned to double digits after two quarters, although
those of professional forecasters remained anchored. Rural wage growth
was moderate but there are indications of incipient pressures from
corporate staff costs.
9. Liquidity
conditions have been very easy in June and July. A seasonal reduction
in demand for currency and increased spending by Government coupled with
structural factors such as low credit deployment relative to the volume
of deposit mobilisation contributed to surplus conditions in the money
markets. This resulted in a significantly lower average daily net
liquidity injection under the fixed rate repos under LAF, and variable
rate term repo/reverse repo and MSF at 477 billion in June, down from
1031 billion in May. In July there was net absorption of 120 billion
through these facilities. In response to the reduction in the policy
repo rate in June the weighted average call rate eased from 7.47 per
cent in May to 7.11 per cent in June. The Reserve Bank also conducted
open market sales worth 83 billion in the second week of July,
essentially in response to lack of demand for longer duration reverse
repos. The call money rate remained below the repo rate through July,
reflecting comfortable liquidity conditions.
10.
Headwinds from weak global demand conditions restrained merchandise
exports. The contraction in exports in Q1 of 2015-16, both volume and
value, was the steepest since Q2 of 2009-10. The sharp fall in
international commodity prices - especially crude oil - compressed
import payments, helping to narrow the trade deficit. Domestic
production shortages and lower international prices were, however,
evident in higher imports of electronic goods, pulses, iron ore and
fertilisers. Net surpluses on account of trade in services were
sustained in Q1 and have, along with the lower trade deficit, helped
reduce the current account deficit (CAD). Despite slowing portfolio
flows, other forms of foreign capital flows such as foreign direct
investment and non-resident deposits were sustained. With the shrinking
external financing requirement, reserves were built up to an all-time
high at the end of June, providing a buffer against adverse global
shocks.
Policy Stance and Rationale
11. The
bi-monthly policy statements of April and June indicated that the
accommodative stance of monetary policy will be maintained going
forward, but monetary policy actions will be conditioned by (a) fuller
transmission by banks of the Reserve Bank’s front-loaded rate reductions
into their lending rates; (b) developments in food prices and their
management, especially the effects of the monsoon, while looking through
both seasonal as well as base effects; (c) a continuation and even
acceleration of policy efforts to unclog the supply side so as to make
available key inputs such as power and land, as also repurposing of
public spending from poorly targeted subsidies towards public investment
and reducing the pipeline of stalled investment; and (d) signs of
normalisation of the US monetary policy. In the June statement, it was
pointed out that a targeted infusion of bank capital is also warranted
so that adequate credit flows to the productive sectors as investment
picks up.
12. Since
the first rate cut in January, the median base lending rates of banks
has fallen by around 30 basis points, a fraction of the 75 basis points
in rate cut so far. As loan demand picks up in Q3 of 2015-16, banks will
see more gains from cutting rates to secure new lending, and more
transmission will take place. The welcome announcement by Government of
infusion of bank capital into public sector banks will help loan growth
and hence transmission, as will currently easy liquidity conditions.
13.
During 2015-16 so far, inflation conditions have evolved around the path
projected in April and June bi-monthly policy statements, though they
surprised somewhat on the upside in June. Large base effects, which the
Reserve Bank will look through, are expected to pull down headline
inflation in July and August. From September, favourable base effects
wane.
14. Turning
to the balance of inflation risks, most worrisome is the sustained
hardening of inflation excluding food and fuel. Moreover, the full
effects of the service tax increase, which took effect from June, will
feed through over the rest of the year. Some food prices, particularly
of protein-rich items, pulses and oilseeds have risen sharply in recent
months. They will have to be carefully monitored as they tend to be
sticky and impart an upward bias to inflation and inflation
expectations. This assumes significance in view of households’ inflation
expectations rising again. Several factors, however, could have a
significant mitigating influence. These include the sharp fall in crude
prices since June and the likelihood of this softness persisting in view
of the global supply glut and expanding production by Iran; the welcome
increase in planting of pulses and oilseeds and prospects of rainfall
in August and September according to some forecasters; the effects of
the Government’s current pro-active supply management to contain shocks
to food prices, especially of vegetables, alongside its decision to keep
increases in minimum support prices moderate.
15. Relative
to the projections of the second bi-monthly statement, inflation
projections in this bi-monthly statement are elevated by the higher than
expected June observation but reduced by prospects of softer crude
prices and a near-normal monsoon thus far. This implies that inflation
projections for January-March 2016 are lower by about 0.2 per cent, with
risks broadly balanced around the target of 6.0 per cent for January
2016 (Chart 1).
Third Bi-monthly Monetary Policy Review, 2015-16 for Bank Exams |
16. Taking
into account all this, and given that policy action was front-loaded in
June, it is prudent to keep the policy rate unchanged at the current
juncture while maintaining the accommodative stance of monetary policy.
Short term real risk free rates are nevertheless supportive of borrowing
by interest rate sensitive consumer segments such as housing and
automobiles. Significant uncertainty will be resolved in the coming
months, including the likely persistence of recent inflationary
pressures, the full monsoon outturn, as well as possible Federal Reserve
actions. As the Reserve Bank awaits greater transmission of its
front-loaded past actions, it will monitor developments for emerging
room for more accommodation.
17. The
outlook for growth is improving gradually. Favourable real income
effects could accrue from weaker commodity prices, in particular crude
oil, and a possible step-up in agricultural activity if monsoon
conditions continue to improve. On the other hand, global growth
projections for 2015 have generally been revised downwards and,
therefore, the export contraction could become a prolonged drag on
growth going forward. Notwithstanding some improvement in the state of
stalled projects, supply constraints continue to be binding and new
investment demand emanating from the private sector and the central
Government remains subdued. On an assessment of the evolving balance of
risks, the projected output growth for 2015- 16 has been retained at 7.6
per cent (Chart 2).
Third Bi-monthly Monetary Policy Review, 2015-16 for Bank Exams |
18. The fourth bi-monthly monetary policy statement will be announced on September 29, 2015.
Third Bi-monthly Monetary Policy Review, 2015-16 for Bank Exams
Reviewed by Newstechcafe
on
August 04, 2015
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