Policy
Measures
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The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.25%.
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With a view to ensuring finer alignment of the weighted average call rate (WACR), the operating target of monetary policy, with the repo rate it has been decided to further narrow the policy rate corridor around the policy repo rate to +/-25bps from +/- 50bps with immediate effect. Consequently, the reverse repo rate under the LAF is at 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.50%.
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The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth.
Assessment
Indicators
of global growth suggest signs of stronger activity in most AEs and
easing of recessionary conditions in commodity exporting large
emerging market economies (EMEs). For EMEs, the outlook is gradually
improving, with indications that the slowdown characterising 2016
could be bottoming out.
Inflation is edging up in AEs to
or above target levels on the back of slowly diminishing slack,
tighter labour markets and rising commodity prices. Among EMEs, there
is a generalised softening of inflation pressures.
International
financial markets have been impacted by policy announcements in major
AEs, geo-political events and country-specific factors. Equity
markets in AEs were driven up by reflation trade, stronger incoming
data and currency movements. Equity markets in EMEs had a mixed
performance, reflecting domestic factors amidst a cautious return of
investor appetite and capital flows.
The
CSO released its second advance estimates for 2016-17 on February 28,
placing India’s real GVA growth at 6.7% for the year, down from 7%
in the first advance estimates released on January 6. Agriculture
expanded robustly; in the industrial sector, there was a significant
loss of momentum across all categories, barring electricity
generation; and the services sector also slowed, pulled down by most
categories of services.
Several
indicators are pointing to a modest improvement in the macroeconomic
outlook. Foodgrains production has touched an all-time high.
Industrial output, measured by the index of industrial production
(IIP), recovered in January from a contraction in the previous month,
helped by a broad-based turnaround in manufacturing as well as mining
and quarrying.
The manufacturing purchasing
managers’ index (PMI) remained in expansion mode in February and
rose to a five month high in March on the back of growth of new
orders and output. The 77th round of the Reserve Bank’s
industrial outlook survey indicates that overall business sentiment
is expected to improve in Q1 of 2017-18 on the back of a sharp pick
up in both domestic and external demand. Coincident indicators such
as exports and non-oil non-gold imports are indicative of a brighter
outlook for industry, although the sizable under-utilisation of
capacity in several industries could operate as a drag on investment.
After
moderating continuously over the last six months to a historic low,
retail inflation measured by year-on-year changes in the CPI turned
up in February to 3.7%. While food prices bottomed out at the
preceding month’s level, base effects pushed up inflation in this
category. Fuel inflation increased as the continuous hardening
of international prices lifted domestic prices of petroleum. Kerosene
prices have also been increasing since July with the programmed
reduction of the subsidy. Both three months ahead and a year
ahead households’ inflation expectations, reversed in the latest
round of the Reserve Bank’s survey. The 77th round of the
Reserve Bank’s industrial outlook survey indicates that pricing
power is returning to corporates as profit margins get squeezed by
input costs. Excluding food and fuel, inflation moderated in February
by 20 basis points to 4.8%, essentially on transient and specific
factors in items like clothing and gold.
With
progressive remonetisation, the surplus liquidity in the banking
system declined from a peak of Rs.7,956 billion on January 4, 2017 to
an average of Rs. 6,014 billion in February and further down to Rs.
4,806 billion in March. Currency in circulation expanded during this
period. Its impact on the liquidity overhang was, however, partly
offset by a significant decline in cash balances of the Government up
to mid-March which released liquidity into the system. Thereafter,
the build-up of Government cash balances on account of advance tax
payments and balance sheet adjustment by banks reduced surplus
liquidity to Rs. 3,141 billion by end-March. Issuances of cash
management bills (CMBs) under the MSS ceased in mid-January and
existing issues matured, with the consequent release of liquidity
being absorbed primarily through variable rate reverse repo auctions
of varying tenors. Accordingly, the average net absorption by the
Reserve Bank increased from Rs. 2,002 billion in January to Rs. 4,483
billion in March. The weighted average call money rate (WACR)
remained within the LAF corridor. The maturing of CMBs and reduced
issuance of Treasury bills leading up to end-March has also
contributed to Treasury bill rates being substantially below the
policy rate.
Merchandise
exports rose strongly in February 2017 from a subdued profile in the
preceding months. Growth impulses were broad-based. The surge
in imports in January and February 2017 largely reflected the effect
of the hardening of commodity prices such as crude oil and coal. With
imports outpacing exports, the trade deficit widened in January and
February from its level a year ago, though it was lower on a
cumulative basis for the period April-February 2016-17. Balance of
payments data for Q3 indicate that the current account deficit for
the first three quarters of the financial year narrowed to 0.7% of
GDP, half of its level a year ago. For the year as a whole, the
current account deficit is likely to remain muted at less than 1% of
GDP.
Foreign
direct investment (FDI) has dominated net capital inflows during
April-December, with manufacturing, communication and financial
services being the preferred sectors. FPI flows turned positive in
February and welled up into a surge in March, especially in debt
markets. This reversal appears to have been driven by stable domestic
inflation, better than expected domestic growth, encouraging
corporate earnings, clarity on FPI taxation, pro-reform budget
proposals and state election results. The level of foreign exchange
reserves was US$369.9 billion on March 31, 2017.
Outlook
GVA
growth is projected to strengthen to 7.4% in 2017-18 from 6.7% in
2016-17, with risks evenly balanced. The pace of remonetisation will
continue to trigger a rebound in discretionary consumer spending.
Significant improvement in
transmission of past policy rate reductions into banks’ lending
rates post demonetisation should help encourage both consumption and
investment demand of healthy corporations. Various proposals in the
Union Budget should stimulate capital expenditure, rural demand, and
social and physical infrastructure all of which would invigorate
economic activity. The imminent materialisation of structural reforms
in the form of the roll-out of the GST, the institution of the
Insolvency and Bankruptcy Code, and the abolition of the Foreign
Investment Promotion Board will boost investor confidence and bring
in efficiency gains. The upsurge in IPOs in the primary capital
market augurs well for investment and growth. External demand should
support domestic growth. Downside risks to the projected growth path
stem from the outturn of the south west monsoon; ebbing consumer
optimism on the outlook for income, the general economic situation
and employment as polled in the March 2017 round of the Reserve
Bank’s consumer confidence survey; and, commodity prices, other
than crude, hardening further.
Headline
CPI inflation is set to undershoot the target of 5.0% for Q4 of
2016-17 in view of the sub-4% readings for January and February. For
2017-18, inflation is projected to average 4.5% in the first half of
the year and 5% in the second half. Aggregate demand pressures could
build up, with implications for the inflation trajectory.
Developmental
and Regulatory Policies
The
RBI also sets out new measures for further refining the liquidity
management framework (Management of Surplus Liquidity, Narrowing of
the Monetary Policy Rate Corridor, Substitution of Collateral under
the LAF Term Repos); strengthening the banking regulation and
supervision (Revised Prompt Corrective Action (PCA) Framework for
Banks, Raising the Minimum Level of Net Owned Funds for ARCs, Partial
Credit Enhancement, Banking Outlets in
underserved areas, banks’ participation in Real Estate Investment
Trust (REITS) and Infrastructure Investment Trusts, Countercyclical
Capital Buffer); broadening and deepening financial markets (Draft
Guidelines on Simplified Hedging Facility for Forex Exposure,
Introduction of Tri-party Repo, Introduction of Additional Settlement
Batches for NEFT, Merchant Discount Rate rationalization, Issuance
and Operation of Pre-paid Payment Instruments); and extending the
reach of financial services by enhancing the efficacy of the payment
and settlement systems (Pilot Project on Financial Literacy).
