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RBI’s Bi-Monthly Policy Review, June 2016

The Reserve Bank of India kept the repo rate unchanged at 6.5 percent in the second bi-monthly monetary policy announced on Tuesday, 7th June 2016. It also kept the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent. In its statement, RBI cited that since the first bimonthly statement in April 2016, the global demand has been uneven and is struggling to gain traction. It also mentioned that in an environment of weak demand, the world trade remained mute. On the domestic front, recent labour market activity indicators also showed weakening signs.

Reasons for maintaining Repo Rate

Dr. Raghuram Rajan in his opening remarks at the press conference mentioned that there has been a more than expected upsurge in inflationary pressures arising from a number of food items (beyond seasonal effects), as well as a reversal in commodity prices. Under these uncertain circumstances the rate cut has been put on hold, but the monetary policy remains accommodative.

Inflation: CPI inflation excluding food and fuel has edged up in April, driven by prices of petrol and diesel embedded in transport and communication. Firming international commodity prices, particularly of crude oil, the implementation of the 7th Central Pay Commission awards, taking these factors into account, the RBI governor said that the inflation projections given in the April policy statement are retained, though with an upside bias. He added that the capacity utilization indicators suggest that the available headroom in industry could keep output prices subdued even as demand picks up. Taking all these in account, considerable uncertainty surrounds the future trajectory of inflation.

Cpi inflation

Figure 1: Quarterly Projections of CPI Inflation (Y-O-Y)

 Liquidity: Due to the maturing of FCNR-B deposits, RBI’s anticipates that the leveraged portions of those deposits will not be renewed deposits, which would create a possibility of $20 billion outflow. Dr. Rajan mentioned that RBI has covered those requirements in the forward markets, and will take some advance deliveries in the lead up to the maturation of the deposits. In case of extreme volatility, RBI will supply dollars to avoid dollar shortage in the market.

Transmission of earlier rate cuts: Banks are yet to fully transmit the earlier rate cuts onto consumers. This is one of the key reason for RBI to maintain the repo rate. Banks, however have their own reasons for not lowering lending rates. There is demand deficiency in the economy. Borrowers and lenders are responding more to income effect. Global growth has been slow and hence it has led to capacity underutilization. Once demand is back, banks would be more inclined to lower lending rates.

Impact on Economy

Maintaining status quo on repo rate would lengthen the time real estate sector takes to come back on the rails. Since demand in real estate and allied industries remains sluggish, a rate cut could have improved liquidity and created renewed interest in property purchase.

Credit rating agency Moody’s Investors Service mentioned that With the Reserve Bank of India (RBI) not altering policy rates, it will be only the transmission of monetary policy that would influence India’s economic development and credit profile.

The way forward should be government’s reform measures on small savings rates combined with the Reserve Bank’s refinements in the liquidity management framework to help the transmission of past policy rate reductions into lending rates of banks. The Industry is hopeful that further rate cut would be announced by the RBI in the next monetary policy review to be held on August 9, 2016 which will help in bridging the demand, supply gap and bring liquidity to the market.

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