Frontloading by RBI signals a long pause



On the basis of an assessment of the current and evolving macroeconomic situation, the RBI has decided to:   Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5% to 7.25% with immediate effect;   Keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0% of net demand and time liabilities (NDTL);   Continue to provide liquidity under overnight repos at 0.25% of bank-wise NDTL at the LAF repo rate and liquidity under 14-day term repos as well as longer term repos of up to 0.75% of NDTL of the banking system through auctions; and   Continue with overnight/term variable rate repos and reverse repos to smooth liquidity.   Consequently, the reverse repo rate under the LAF stands adjusted to 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate to 8.25%.   The ‘frontloading’ of rate cut, as RBI governor terms it, hints that the central bank may well take a pause as far as rate cuts are concerned. In  line with the broader consensus, RBI decided to trim repo rate by 25 basis points and kept the CRR unchanged at 4%. However, the wording of monetary policy remains cautious and indicates a long pause before the next move on the interest rates. The policy statement mentions that there is an element of uncertainty to the inflation outlook, wherein the probability of poor monsoon and volatility in oil prices pose as a serious risk. Governor Raghuram Rajan has added that the interest rate move in June is front loaded, which otherwise would had occurred in August. This implies that next policy meeting in August will yield nothing much on the interest rates front.   In spite of recent moderation in inflationary levels, the upside risk to food inflation is palpable considering the forecasts for below normal monsoon this year. India’s Meteorological Department expects the total rainfall to be 93% of the normal monsoon. In addition, output of food grains has contracted due to a series of unseasonal rains in most parts of the nation this year. The buffer stocks for pulses and oilseeds are also estimated to be lower. As a result, RBI expects retail inflation to start rising from August till 6% by January 2016, slightly higher than the projections in April.  On oil front, although the upside in prices is capped due to comfortable global supply situation, energy markets are always prone to supply side shocks.   The central bank acknowledged that economic growth is slowing, characterized by subdued corporate earnings and other macroeconomic indicators. Real demand has not picked up; and the economic growth still below potential. There has been downward revision to Gross value added estimates for FY2014-15, while the projection for output growth for 2015-16 has been marked down to 7.6% from the previous estimate of 7.8%. However, Mr. Rajan stated that the government is taking steps to stimulate recovery. The incumbent regime has initiated measures to unclog the investment pipeline; however ground reality is not inspiring.   Mr. Rajan mentioned that that money market instruments like Commercial Paper and Certificate of Deposits are reflecting the series of rate cuts this year. Nevertheless, transmission of monetary policy is not evident in all aspects and takes time for the effect to percolate. Moderation in interest on Commercial Papers is putting pressure on banks to lower the rates. It now depends on the banks whether to focus on margins or market share. Sovereign bond yields have already moved lower, banks should transmit the benefits.   Monetary policy will continue to be data driven and will not have any conservative or aggressive bias. The central bank remains dedicated to its disinflationary stance; however it is open to monetary easing if the macroeconomic situation permits the same. The next move is primarily dependent on the developments on the monsoon and ensuing effects on inflation. Better monsoons and positive government action can only pave the path for further change in the interest rates. However, considering the fact that there is high possibility of monsoons being below normal and its adverse impact on food inflation, we do not expect the RBI to act on the interest rates for at least next two monetary policy meetings. Nevertheless, better fiscal consolidation, proper food management policies and effective reforms by the government should ensure additional rate cuts to the tune of 50 basis points by the end of this fiscal year.