Policy
Measures
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The Monetary Policy Committee (MPC) decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) from 6.25% to 6.00% with immediate effect.
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Consequently, the reverse repo rate under the LAF stands adjusted to 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.25%.
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Inflation excluding food and fuel, which has hitherto been sticky, has fallen significantly over past three months. These factors along with the normal and well distributed rainfall and the smooth rollout of the GST opened up some space for Monetary Policy accommodation. Accordingly, the MPC decided by a vote of 4 to 2 to reduce the policy rate by 25 basis points.
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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
Impulses
of growth have spread across the global
economy albeit still
lacking the strength of a self-sustaining recovery. Among the AEs,
the US has expanded at a faster pace in Q2 after a weak Q1, supported
mostly by steadily improving labour market conditions. In the Euro
area, the recovery has broadened across constituent economies on the
back of falling unemployment and a pickup in private consumption.
In
Japan, a modest but steady expansion has been taking hold,
underpinned mostly by strengthening exports. Among EMEs, growth has
regained some lost ground in China in Q2. The Russian economy
has emerged out of two years of recession.
In
Brazil, a fragile recovery remains vulnerable to political
uncertainty and a still depressed labour market. South Africa is in a
technical recession as economic activity in continues to be beset by
structural and institutional bottlenecks.
The
modest firming up of global demand and stable commodity prices have
supported global trade volumes, reflected in rising exports and
imports in key economies. In the second half of July, crude prices
have risen modestly out of bearish territory on account of inventory
drawdown in the US, but the supply overhang persists. Chinese demand
has fuelled a recent rally in metal prices. However, inflation is
well below target in most AEs and is subdued across most EMEs.
International
financial markets
have been resilient to political uncertainties and volatility has
declined. Equity markets in most AEs have registered gains, with
indices crossing previous highs in the US.
In
EMEs, equities have gained on surging global risk appetite.
Bond
yields in major AEs have hardened on expectations of monetary policy
normalization, while in EMEs fixed-income markets have been generally
insulated from the bond sell-off in AEs. In the currency markets, the
US dollar weakened further and fell to a multi-month low in July. The
euro, which has remained bullish, rallied further on upbeat economic
data.
EME
currencies largely remained stable and have traded with an
appreciating bias.
In
India
a normal and well-distributed south-west monsoon for the second
consecutive year has brightened the prospects of agricultural and
allied activities and rural demand. Meanwhile, procurement
operations in respect of rice and wheat during the rabi marketing
season have been stepped up to record levels.
Industrial
performance
has weakened in April-May 2017, mainly reflecting a broad-based loss
of momentum in manufacturing. The output of consumer
non-durables accelerated and underlined the resilience of rural
demand. It was overwhelmed, however, by contraction in consumer
durables – indicative of still sluggish urban demand – and in
capital goods, which points to continuing retrenchment of capital
formation in the economy. The weakness in the capex cycle was also
evident in the number of new investment announcements falling to a
12-year low in Q1, the lack of traction in the implementation of
stalled projects, deceleration in the output of infrastructure goods,
and the ongoing deleveraging in the corporate sector. The output of
core industries was also dragged down by contraction in electricity,
coal and fertiliser production in June, owing to excess inventory and
tepid demand.
The
78th round of the Reserve Bank’s industrial
outlook survey
revealed a waning of optimism in Q2 about demand conditions across
parameters, and especially on capacity utilisation, profit margins
and employment. The manufacturing PMI moderated sequentially to a
four-month low in June and in July, the PMI declined into the
contraction zone with a decrease in new orders and a deterioration in
business conditions, reflecting inter
alia the
roll out of the GST.
In
June, retail
inflation
measured by year-on-year changes in the CPI plunged to its lowest
reading in the series based to 2011-12. This was mainly the outcome
of large favourable base effects which are slated to dissipate and
reverse from August. Prices of food and beverages, which went
into deflation in May 2017 for the first time in the new CPI series,
sank further in June as prices of pulses, vegetables, spices and eggs
recorded year-on-year declines and inflation moderated across most
other sub-groups. . Fuel inflation declined for the second month
in succession as international prices of LPG fell and price increases
moderated in other categories.
Excluding
food and fuel, CPI inflation moderated for the third month in
succession in June, falling to 4%.
Surplus
liquidity
conditions
persisted in the system, exacerbated by front-loading of budgetary
spending by the Government. Surplus liquidity of Rs. 1 trillion
was absorbed through issuance of treasury bills (TBs) under the MSS
and Rs. 1.3 trillion through CMBs on a cumulative basis so far this
financial year. Enduring surplus conditions warranted outright open
market sales of Rs.100 billion each on two occasions in June and
July.
Apart
from these operations, net average absorption of liquidity under the
LAF was at Rs. 3.1 trillion in June and Rs. 3.0 trillion in July.
Reflecting this active liquidity management, the weighted average CMR
firmed up and traded about 17 bps below the repo rate on average
during June and July.
Merchandise
export
growth weakened in May and June from the April peak as the value of
shipments across commodity groups either slowed or declined. By
contrast, import
growth
remained in double digits, primarily due to a surge in oil imports
and stockpiling of gold imports ahead of the implementation of the
GST.
As
import growth continued to outpace export growth, the trade
deficit
at US$40.1 billion in Q1 was more than double its level a year ago.
Net
FDI
doubled in April-May 2017 over its level a year ago, flowing mainly
into manufacturing, retail and wholesale trade and business services.
FPIs
made net purchases of US$15.2 billion in domestic debt and equity
markets so far (up to July 31), remaining bullish on the outlook for
the Indian economy. The level of foreign
exchange reserves
was US$392.9 billion as on July 28, 2017.
Outlook
The
projection
of real GVA growth for 2017-18
has been retained at the June 2017 projection of 7.3 per cent, with
risks evenly balanced. Business sentiment in the manufacturing sector
reflects expectations of moderation of activity in Q2 of 2017-18 from
the preceding quarter. Moreover, high levels of stress in twin
balance sheets – banks and corporations – are likely to deter new
investment. With the real estate sector coming under the regulatory
umbrella, new project launches may involve extended gestations and,
along with the anticipated consolidation in the sector, may restrain
growth, with spillovers to construction and ancillary activities.
Also, given the limits on raising market borrowings and taxes by
States, farm loan waivers are likely to compel a cutback on capital
expenditure, with adverse implications for the already damped capex
cycle. At the same time, upsides to the baseline projections emanate
from the rising probability of another good kharif harvest,
the boost to rural demand from the higher budgetary allocation to
housing in rural areas, the significant step-up in the budgetary
allocation for roads and bridges, and the growth-enhancing effects of
the GST, viz.,
the shifting of trade from unorganised to organised segments; the
reduction of tax cascades; cost, efficiency and competitiveness
gains; and synergies in domestic supply chains. External demand
conditions are gradually improving and should support the domestic
economy.
The
second bi-monthly statement projected quarterly average headline
inflation
in the range of 2.0-3.5 per cent in the first half of the year and
3.5-4.5 per cent in the second half. The actual outcome for Q1 has
tracked projections. Looking ahead, as base effects fade, the
evolving momentum of inflation would be determined by (a) the impact
on the CPI of the implementation of house rent allowances (HRA) under
the 7th central pay commission (CPC); (b) the impact of the price
revisions withheld ahead of the GST; and (c) the disentangling of the
structural and transitory factors shaping food inflation. The
inflation trajectory has been updated taking into account all these
factors and incorporates the first round impact of the implementation
of the HRA award by the Centre.
Excluding
the HRA impact, which will affect the CPI cumulatively, headline
inflation would be a little above 4% by Q4, as against 4.5% inclusive
of the HRA in the June statement. However,
there
are several factors contributing to uncertainty on both sides around
this baseline inflation trajectory.
Developmental
and Regulatory Policies
The
RBI also set out measures to improve policy transmission and
financial intermediation in the economy:
The
experience with the MCLR system introduced in April 2016 for
improving monetary
policy transmission
has not been entirely satisfactory, even though it has been an
advance over the Base Rate system. Given a large part of the
floating rate loan portfolio of banks is still anchored on the Base
Rate, the RBI will be exploring various options in the near future to
make the Base Rate more responsive to changes in cost of funds of
banks.
Final
guidelines set out for Tri-party
Repo
aimed to pave the way for a vibrant corporate bond borrowing and
lending market, providing better liquidity and price discovery,
reducing market cost of capital and allowing access to non-bank
finance for a greater number of borrowers in the economy.
Task
force to evaluate the existing public and private infrastructure for
credit information, assess any data gaps, study the best
international practices and provide a road map for the development of
a comprehensive near real-time public credit
registry
for India.
Guidelines
on Liquidity Coverage Ratio (LCR) have been revised such that
reserves held by banks incorporated in India with a foreign central
bank, in excess of the reserve requirement in the host country,
should be treated as High
Quality Liquid Assets
(HQLAs), subject to certain conditions.
The
circular to operationalize the scheme of simplified
hedging facility has
been finalized. The scheme aims to simplify the process for hedging
exchange rate risk by reducing documentation requirements and
avoiding prescriptive stipulations regarding products, purpose and
hedging flexibility.
Separate
limit of Interest Rate Futures (IRFs) for FPIs
to be introduced to ensure FPIs’ access to futures remains
uninterrupted during the phase when FPI limits on Government
securities are under auction. It is proposed to allocate FPIs a
separate limit of Rs. 5,000 crore for long position in IRFs. The
limits prescribed for investment by FPIs in Government securities
will then be exclusively available for acquiring such securities.
