A summary of the Second
Bi-Monthly Monetary Policy Statement of FY 2015-16 announced today by RBI–
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Reduce Repo and Reverse Repo rate to 7.25% and 6.25% respectively – A
cut of 25bps
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Marginal Standing Facility (MSF) and Bank Rate also reduced to 8.25%
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No Change in CRR. Unchanged at 4.00% of Net Demand and Time Liabilities
(NDTL)
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RBI will continue to provide liquidity under overnight repos at 0.25% of
bank-wise NDTL at the LAF repo rate
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RBI will also continue to provide liquidity under 14-day and longer term
repos of up to 0.75% of NDTL of the banking system through auctions
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Continue with overnight/term variable rate repos and reverse repos to
smooth liquidity
Summary of RBI’s Assessment
Global economic assessment-
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Global recovery is still slow and getting increasingly differentiated
across regions
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In the United States, the economy shrank in Q1 owing to harsh weather
conditions, the strength of the US dollar weighing on exports and a decline in
non-residential fixed investment
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In the euro area, financial conditions have eased due to the European
Central Bank’s (ECB) quantitative easing and a depreciating euro. There has,
however, been some moderation in composite purchasing managers’ indices (PMI),
economic sentiment and consumer confidence in April
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In Japan, growth surprised on the upside in Q1, supported by private
demand as business spending boosted inventories and personal consumption
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China continues to decelerate in spite of monetary easing
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The deterioration in export performance affected economies across Asia
as global demand fell and the fall in commodity prices impacted terms of trade
for commodity exporters
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For most emerging market economies (EMEs), macroeconomic conditions
remain challenging due to domestic fragilities, exacerbated by bouts of
financial market turbulence
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Volatility in global bond markets has increased with a number of
factors at play: unwinding of European assets by investors due to the Greek
crisis; rapidly changing expectations around the Fed’s forward guidance; sharp
movements in crude prices; and market corrections due to changes in risk
tolerance
Domestic
Economic Assessment-
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Domestic economic activity remains moderate in Q1 of 2015-16.
Agricultural activity was adversely affected by unseasonal rains and hailstorms
in north India during March 2015, impinging on an estimated 94 lakh hectares of
area sown under the rabi crop
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For the kharif season, the outlook is clouded by the first estimates of
the India Meteorological Department (IMD), predicting that the southwest
monsoon will be 7 per cent below the long period average
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Industrial production has been recovering, albeit unevenly
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The disappointing earnings performance could have been worse if not for
the decline in input costs.
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Some public sector banks will need more capital to clean up their
balance sheets and support lending as investment revives
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Leading indicators of services sector activity are emitting mixed
signals. The services PMI declined in April 2015, mainly on account of slowdown
in new business orders. Community and personal services are likely to be held
back by the ongoing fiscal consolidation
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Merchandise export growth has weakened steadily since July 2014 and
entered into contraction from January 2015 through April, with a recent
shrinking of even volumes exported
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From December 2014 onwards, merchandise import growth also turned negative,
led by a sharp decline in the volume of oil imports as inventory build-up by
refineries subsided
Assessment
of Inflationary Trends-
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In April, retail inflation measured by the consumer price index (CPI)
decelerated for the second month in a row, supported by favourable base effects
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Food inflation softened to a contra-seasonal four-month low, with the
impact of unseasonal rains yet to show up
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Fuel inflation rose for the fourth successive month to a twelve-month
high, driven by prices of electricity and firewood
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Rural wage growth, although still moderate, picked up
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Inflation expectations remain in high single digits, although they may
adapt further to current low inflation
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Both input and output price pressures remain muted as reflected in the
Reserve Bank’s industrial outlook survey
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Estimates have been pointing to a worsening of the Food inflationary
situation, with the damage to crops like pulses and oilseeds – where buffer
foodstocks are not available in the central pool – posing an upside risk to
food inflation
Domestic
Growth Outlook-
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Given weakening of exports and imports with a spike in gold imports, the
reduction in the current account deficit resulting from the sharp decline in
oil prices has begun to reverse, though the size of the deficit is expected to
be contained to about 1.5 per cent of GDP this year
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Net exports are, therefore, unlikely to contribute as much to growth
going forward as they did in the past financial year. Growth will depend more
on a strengthening of domestic final demand
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Portfolio and direct foreign investment flows were buoyant during
2014-15, with net foreign direct investment to India at US$ 36.6 billion and
net portfolio inflows at US$ 41 billion, the year 2015-16 has begun with net
portfolio outflows in the wake of a reduction in global portfolio allocations
to India
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Foreign exchange reserves are around US$ 350 billion, providing a
strong second line of defence to good macroeconomic policies if external
markets turn significantly volatile
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Reflecting the balance of risks and the downward revision to GVA
estimates for 2014-15, the projection for output growth for 2015-16 has been
marked down from 7.8 per cent in April to 7.6 per cent with a downward bias to
reflect the uncertainties surrounding these various risks
Key factors leading to
maintenance of policy stance –
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Banks have started passing through some of the past rate cuts into their
lending rates, headline inflation has evolved along the projected path
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The impact of unseasonal rains has been moderate so far, administered
price increases remain muted
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The timing of normalisation of US monetary policy seems to have been
pushed back
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With low domestic capacity utilization, still mixed indicators of
recovery, and subdued investment and credit growth, there is a case for a cut
in the policy rate today
Policy Stance
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Contingency plans for food management, including storage of adequate
quantity of seeds and fertilisers for timely supply, crop insurance schemes,
credit facilities, timely release of food stocks and the repair of disruptions
in food supply chains, including through imports and de-hoarding, need to be in
place to manage the impact of low production on inflation
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Clear evidence of a revival in investment demand will need to build on
the tentative indications of unclogging of stalled investment projects,
stabilising of private new investment intentions and improving sales of
commercial vehicles
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There are 3 risk to inflation identified by RBI viz.
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Weather forecasters, notably the IMD, predict a below-normal
southwest monsoon. Astute food management is needed to mitigate possible
inflationary effects
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Crude prices have been firming amidst considerable volatility, and
geo-political risks are ever present
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Volatility in the external environment could impact inflation
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Therefore, a conservative strategy would be to wait, especially for
more certainty on both the monsoon outturn as well as the effects of government
responses if it turns out to be weak
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With still weak investment and the need to reduce supply constraints
over the medium term to stay on the proposed disinflationary path (to 4 per
cent in early 2018), however, a more appropriate stance is to front-load a rate
cut today and then wait for data that clarify uncertainty
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Meanwhile banks should pass through the sequence of rate cuts into
lending rates
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Strong food policy and management will be important to help keep
inflation and inflationary expectations contained over the near term
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Monetary easing can only create the enabling conditions for a fuller
government policy thrust that hinges around a step up in public investment in
several areas that can also crowd in private investment. This will be important
to relieve supply constraints and aid disinflation over the medium term
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A targeted infusion of bank capital into scheduled public sector
commercial banks, especially those that implement concerted strategies to clean
up stressed assets, is also warranted so that adequate credit flows to the
productive sectors as investment picks up
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