Highlights of RBI’s Third Bi-monthly Monetary Policy Statement, 2016-17

Policy Measures

* Repo rate unchanged at 6.50 per cent, Reverse Repo at 6%, Bank rate and MSF rate at 7%

* Cash reserve ratio or CRR unchanged at 4%

*Continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality

Assessment

Since the second bi-monthly statement of June 2016, several developments have clouded the outlook for the global economy. Q2 growth has been slower than anticipated across AEs, with the Brexit vote increasing uncertainty. Among EMEs, activity remains varied. GDP growth stabilised in China in Q2. Recessionary conditions are gradually diminishing in Brazil and Russia, but the near-term outlook is still fragile. In India, monsoon related developments engender greater confidence about the near-term outlook for value added in agriculture. Barring the contraction in natural gas and crude oil on account of structural bottlenecks, the core sector has been resilient as of 2016-17 so far, and should support industrial activity going forward. There are some signs of green shoots in manufacturing too, with PMIs and the Reserve Bank’s industrial outlook survey indicating a pick-up in new orders, both domestic and external. High frequency indicators of service sector activity are still, however, emitting mixed signals, although a larger number of indicators are in acceleration mode in Q1 of 2016-17. Merchandise export growth moved into positive territory in June after eighteen months, with a reasonably widespread upturn. While lower crude oil prices continued to compress the POL import bill, non-oil non-gold imports continued to shrink. Successive downgrades of global growth projections by multilateral agencies and the continuing sluggishness in world trade points to further slackening of external demand going forward. The recent sharper-than-anticipated increase in food prices has pushed up the projected trajectory of inflation. CPI inflation rose to a 22-month high in June, with a sharp pick-up in momentum overwhelming favourable base effects. The rise was mainly driven by food, with vegetable and sugar inflation higher than the usual.

International financial markets did not anticipate the Brexit vote and equities plunged worldwide, currency volatility increased and investors herded into safe havens. Since then, however, equity markets have regained lost ground. Currencies, barring the pound sterling, have stabilized. While the pace of FDI inflows to India slowed in the first two months of 2016-17, net portfolio flows were stronger after the Brexit vote, notwithstanding considerable volatility characterising these flows. The level of foreign exchange reserves rose to US$365.7 billion by August 5, 2016.

Liquidity conditions eased significantly during June and July on the back of increased spending by the Government which more than offset the reduction in market liquidity because of higher-than-usual currency demand. The injection of durable liquidity through purchases under OMOs, amounting to Rs. 805 billion so far, also helped in easing liquidity conditions, bringing the system-level ex ante liquidity deficit to close to neutrality (without seasonal adjustment). Accordingly, the average daily liquidity operation switched from net injection of liquidity of Rs. 370 billion in June to net absorption of Rs. 141 billion in July and Rs. 405 billion in August (up to August 8). The Reserve Bank conducted variable rate repos and reverse repos of varying tenors in order to manage evolving liquidity conditions, with a more active use of reverse repos to manage the surplus liquidity. Reflecting the easy liquidity conditions, the weighted average call rate (WACR) and money market weighted average rate remained on average 15 basis points below the policy repo rate since June.

Policy Stance and Rationale

• A normal monsoon and the 7th Pay Commission award likely to boost growth
• Implementation of GST should raise returns to investment and thus business
  sentiment and eventually investment
• Impact of direct effect of house rent allowances under the 7th CPC’s award need to be watched
• Growth forecast retained at 7.6% for the current fiscal
• Inflation target kept unchanged at 5% by March 2017 with upward bias
• Easy liquidity conditions are already prompting banks to modestly transmit past policy rate cuts through their MCLRs
• Monetary policy to remain accommodative and will continue to emphasise the adequate provision of liquidity

The refinements to the liquidity management framework effected in April 2016 were intended to smooth the supply of durable liquidity over the year using asset purchases and sales as needed, and progressively lower the average ex ante liquidity deficit in the system to a position closer to neutrality. The Reserve Bank intends to continue with this strategy, with the intention of closing the underlying liquidity deficit over time so that the system moves to a position of structural balance.