Highlights of RBI’s Fourth Bi-monthly Monetary Policy Statement, 2017-18:

Policy Measures

• The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.00%.
• Consequently, the reverse repo rate under the LAF remains unchanged at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.25%.
• 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

Global economic activity has strengthened further and become broad-based. Among advanced economies (AEs), the US has continued to expand with revised Q2 GDP growing at its strongest pace in more than two years, supported by robust consumer spending and business fixed investment. Euro area economic recovery gained further traction, underpinned by domestic demand. While private consumption benefited from employment gains, investment rose on the back of favourable financing conditions. The Japanese economy continued on a path of healthy expansion despite a downward revision in growth since March 2017 on weaker than expected capital expenditure. Strong growth in Q2 in China was powered by retail sales, and imports grew at a rapid pace, suggesting robust domestic demand. The Brazilian economy expanded for two consecutive quarters in Q2 on improving terms of trade, even as the impact of recession persists on the labour market. Economic activity in Russia recovered further, supported by strengthening global demand, firming up of oil prices and accommodative monetary policy. Although South Africa has emerged out of recession in Q2, the economy faces economic and political challenges.

The latest assessment by the WTO indicates a significant improvement in global trade in 2017, backed by a resurgence of Asian trade flows and rising imports by North America. Crude oil prices hit a two-year high in September on account of the combined effect of a pick-up in demand, tightening supplies due to production cuts by the OPEC and declining crude oil inventories in the US. Bullion prices touched a year’s high in early September on account of safe-haven demand due to geo-political tensions. Weak non-oil commodity prices and low wage growth kept inflation pressures low in most AEs and subdued in several EMEs, largely reflecting country-specific factors.

Global financial markets have been driven mainly by the changing course of monetary policy in AEs, generally improving economic prospects and oscillating geo-political factors. Equity markets in most AEs have continued to rise. In EMEs, equities generally gained on improved global risk appetite, supported by upbeat economic data and expectations of a slower pace of monetary tightening in major AEs. While bond yields in major AEs moved sideways, they showed wider variation in EMEs. The euro surged to a two and a half year high against the US dollar towards end-August on positive economic data. Most AE and EME currencies showed divergent movements.

In India GVA growth slowed significantly in Q1 of 2017-18, cushioned partly by the extensive front-loading of expenditure by the central government. GVA growth in agriculture and allied activities slackened in the usual first quarter moderation. Industrial sector GVA growth fell sequentially as well as on a y-o-y basis. The manufacturing sector – the dominant component of industrial GVA – grew by 1.2 per cent, the lowest in the last 20 quarters. The mining sector contracted, services sector performance, however, improved markedly, construction, as well as, financial, real estate & professional services,  picked up pace. Of the constituents of aggregate demand, growth in private consumption expenditure was at a six-quarter low in Q1 of 2017-18. Gross fixed capital formation exhibited a modest recovery in Q1 in contrast to a contraction in the preceding quarter.

The uneven spatial distribution of the monsoon was reflected in the first advance estimates of kharif production, which were below the level of the previous year.

IIP recovered marginally in July 2017 from the contraction in June on the back of a recovery in mining, quarrying and electricity generation. However, manufacturing remained weak. In terms of the use-based classification, contraction in capital goods, intermediate goods and consumer durables pulled down overall IIP growth. In August, however, the output of core industries posted robust growth on the back of an uptick in coal production and electricity generation. 

 Retail inflation, measured by year-on-year change in the CPI, edged up sequentially in July and August to reach a five month high. After a decline in prices in June, food inflation rebounded in the following two months, driven mainly by a sharp rise in vegetable prices. Cereals inflation remained benign, while deflation in pulses continued for the ninth successive month. Fuel group inflation remained broadly unchanged in August. Petroleum product prices tracked the hardening of international crude oil prices. CPI inflation excluding food and fuel also increased sharply in July and further in August, reversing from its trough in June.

A large liquidity overhang, fuelled mainly by the front-loading of government spend, which necessitated frequent recourse to ways and means advances and overdrafts over the greater part of this period, imparted a downside bias to overnight money market rates in H1 of 2017-18. Surplus liquidity in the system persisted through Q2 even as the build-up in government cash balances since mid-September 2017 due to advance tax outflows reduced the size of the surplus liquidity significantly in the second half of the month. Active liquidity operations narrowed the spread between the WACR and the policy rate from 31 bps in April to 13 bps in September. The RBI conducted OMO sales on six occasions during Q2 to absorb Rs. 600 billion of surplus liquidity on a durable basis. Net average absorption of liquidity under the LAF declined from Rs. 3 trillion in July to Rs. 1.6 trillion in the second half of September. The weighted average CMR, which on an average, traded below the repo rate by 18 bps during July, firmed up by 5 bps in September on account of higher demand for liquidity around mid-September in response to advance tax outflows.

Reflecting improving global demand, merchandise export growth picked up in August 2017 after decelerating in the preceding three months. Engineering goods, petroleum products and chemicals were the major contributors to export growth in August 2017; growth in exports of readymade garments and drugs & pharmaceuticals too returned to positive territory. Import growth remained in double-digits for the eighth successive month in August and was fairly broad-based. While the surge in imports of crude oil and coal largely reflected a rise in international prices, imports of machinery, machine tools, iron and steel also picked up. Gold import volume has declined sequentially since June. The sharper increase in imports relative to exports resulted in a widening of the CAD in Q1 of 2017-18, even as net services exports and remittances picked up. Net FDI at US$10.6 billion in April-July 2017 was 24% higher than during the same period of last year. While the debt segment of the domestic capital market attracted FPI of US$14.4 billion, there were significant outflows in the equity segment in August-September on account of geo-political uncertainties and expected normalisation of Fed asset purchases. India’s foreign exchange reserves were at US$399.7 billion on September 29, 2017.

Outlook

 The projection of real GVA growth for 2017-18 has been revised down to 6.7 per cent from the August 2017 projection of 7.3 per cent, with risks evenly balanced. The loss of momentum in Q1 of 2017-18 and the first advance estimates of kharif foodgrains production are early setbacks that impart a downside to the outlook. The implementation of the GST so far also appears to have had an adverse impact, rendering prospects for the manufacturing sector uncertain in the short term. This may further delay the revival of investment activity, which is already hampered by stressed balance sheets of banks and corporates.

Headline inflation was projected at 3 per cent in Q2 and 4.0-4.5 per cent in the second half of 2017-18. Actual inflation outcomes so far have been broadly in line with projections, though the extent of the rise in inflation excluding food and fuel has been somewhat higher than expected. Taking into account domestic and international factors, including food prices, price revisions pending the GST, the house rent allowance by the Centre and international crude prices, inflation is expected to rise from its current level and range between 4.2-4.6 per cent in the second half of this year.

Developmental and Regulatory Policies

The RBI also set out various developmental and regulatory policy measures for further improving monetary transmission; strengthening banking regulation and supervision; broadening and deepening financial markets; and, extending the reach of financial services by enhancing the efficacy of the payment and settlement systems:

Measures to Improve Monetary Policy Transmission: Arbitrariness in calculating the base rate/MCLR and spreads charged over them has undermined the integrity of the interest rate setting process. The base rate/MCLR regime is also not in sync with global practices on pricing of bank loans. A Study Group has, therefore, recommended a switchover to an external benchmark in a time-bound manner.

Banking Regulation and Supervision: As a part of the transition to a LCR of 100% by January 1, 2019, the SLR will be reduced by 50 bps, from 20.0% to 19.50% of banks’ NDTL, from the fortnight commencing October 14, 2017. The ceiling on SLR securities under ‘Held to Maturity’ (HTM) will also be reduced from 20.25% to 19.50% of banks’ NDTL in a phased manner, i.e., 20.00% by December 31, 2017 and 19.50% by March 31, 2018.

High-level Task Force on Public Credit Registry (PCR) will propose a state-of-the-art information system, allowing for existing systems to be strengthened and integrated, and suggest a modular, prioritized roadmap for developing a transparent, comprehensive and near-real-time PCR for India. 

It has been decided to require banks to make it mandatory for corporate borrowers having aggregate fund-based and non-fund based exposure of Rs. 50 million and above from any bank to obtain Legal Entity Identifier (LEI) registration and capture the same in the Central Repository of Information on Large Credits (CRILC). This will facilitate assessment of aggregate borrowing by corporate groups, and monitoring of the financial profile of an entity/group.

The regulatory norms have been eased in order to enable all co-operative banks to open current accounts and maintain CRR with the Reserve Bank. All the regional offices of the Reserve Bank have been advised to issue no objection certificates for opening current accounts for all licensed co-operative banks other than those under all-inclusive directions.

The P2P platform has been notified as an NBFC under section 45I (f) (iii) of the Reserve Bank of India Act, 1934 as per the gazette notification published on September 18, 2017.

 Banks to put in place explicit mechanisms for meeting the needs of senior citizens and differently abled persons for availing banking facilities in branches.

Financial Markets:  The Reserve Bank shall put in place a framework for authorisation of electronic trading platforms (ETP) for financial market instruments regulated by the Reserve Bank. 

A Foreign Exchange Trading Platform is proposed for improving the pricing outcome for the “retail user” (to be defined in terms of transaction size) under which client pricing is directly determined in the market by providing customers with access to an inter-bank electronic trading platform where bid/offers from clients and Authorised Dealer banks can be matched anonymously and automatically.

Non-resident importers and exporters (NRIE) entering into rupee invoiced trade transactions with residents will be permitted to hedge their INR exposures through their centralised treasury/group entities. This is expected to facilitate internationalisation of the rupee by encouraging rupee invoicing of trade transactions while also encouraging non-residents to hedge INR risks onshore.

A detailed review of current regulations on FPI debt investment shall be undertaken to facilitate the process of investment and hedging by FPIs, keeping in mind macro-prudential considerations. Regulatory changes to be finalised in consultation with the Government of India and the SEBI will be effective from April 2018.

Smoother settlement of short sale transactions is necessary for orderly functioning of the market. Towards this end, it has been decided that (i) a short seller need not borrow securities for ‘notional short sales’, wherein it is required to borrow the security even when the security is held in the held-for-trading/available-for-sale/held-to-maturity portfolios of banks; and, (ii) OTC G-sec transactions by FPIs may be contracted for settlement on a T+1 or T+2 basis. 

 In order to further develop liquidity in the State Development Loan (SDL) market, spread the issuance of SDLs, move towards market-based pricing that is sensitive to individual state’s fiscal risk metrics, and reduce uncertainties in announcement of auction results, the following measures are being proposed:

• Consolidation of state government debt will be undertaken to improve liquidity in SDLs through reissuances and buybacks, so as to even out redemption pressures and elongate residual maturity.
• SDL auctions will be conducted on a weekly basis and the auction results will be announced latest by 3.00 PM on the same day.
• High frequency data relating to finances of state governments available with the Reserve Bank will be disclosed on its website.

The Union Budget 2016-17 announced that the Reserve Bank will facilitate retail participation in the primary and secondary markets through stock exchanges. Accordingly, after consultation with the SEBI, it is proposed that:

• specified stock exchanges, in addition to scheduled banks and primary dealers, will be permitted to act as aggregators/facilitators for retail investor bids in the non-competitive segment for the auction of dated securities and treasury bills of the Government of India.

Payment and Settlement:  In line with the Vision for Payment and Settlement Systems in the country, a revised framework will pave the way for bringing inter-operability into usage of PPIs.