Mumbai: The Reserve Bank of India (RBI) held its policy rate at 7.25 percent on Tuesday, pausing as widely expected after a spike in food prices sent consumer inflation to an eight-month high.
All but four of 51 analysts polled by Reuters had predicted the RBI would keep the repo rate on hold.
The central bank has reduced the policy rate by a total 75 basis points since January, when it embarked on an easing cycle.
RBI says banks have passed on an average 0.3 per cent interest rate cut as against its 0.75 per cent rate cut since January.
RBI Governor Raghuram Rajan says at least first set of differential bank licences to be announced by end of this month.
He also added, that the veto power with RBI Governor in proposed monetary policy panel will mean no change from current rate setting practice.
Further, the RBI will also continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL at the Liquidity Adjustment Facility 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.
It will also continue with daily variable rate repos and reverse repos to smooth liquidity.
Consequently, the reverse repo rate under the Liquidity Adjustment Facility will remain unchanged at 6.25 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 8.25 per cent.
Since the last statement issued by RBI, the global economic activity has recovered modestly in Q2 of 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.
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 survey-based 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).
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.
Policy Stance and Rationale
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:
- fuller transmission by banks of the Reserve Bank’s front-loaded rate reductions into their lending rates;
- developments in food prices and their management, especially the effects of the monsoon, while looking through both seasonal as well as base effects;
- 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
- 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.
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.
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
