Third Bi-Monthly Monetary Policy
The third bi monthly monetary policy was announced on 9 August by Mr. Raghuram Rajan, the Governor of Reserve Bank of India (RBI). Citing upside risks to the Reserve Bank’s inflation target for March 2017, RBI maintained status quo on key rates at his last policy review meeting, but underlined that the central bank continues to be accommodative. RBI has kept the policy repo rate under the liquidity adjustment policy (LAF) unchanged at 6.5 per cent. It also kept Cash reserve ratio (CRR) of scheduled banks kept unchanged at 4.0 percent of net demand and time liabilities (NDTL). Consequently, the reverse repo rate under LAF remains unchanged at 6 per cent, and the marginal standing facility (MSF) rate and the bank rate at 7.0 percent.
Rationale behind an Accommodative Policy Stance
The government has kept rates on hold, maintaining an accommodative stance while it awaits development.The main reason behind current policy stance is the projected trajectory of inflation over the rest of the year due to increase in price of food, pulses and inflation. However, there are other factors as well.
The RBI sticks to liquidity neutrality goal and has been working to dissolve the one percent deficit that was maintained in the economy. Although the government has reduced some of the structural liquidity deficit, the current surplus is partly due to seasonal factors. RBI has opted for Open Market Operations to the tune of Rs 80,500 crore so far. This would inject liquidity into the economy and ensure smooth repayments. “With the preparations we have made and good management, redemptions should go smoothly,” said the Governor. It has been decided to conduct an open market purchase auction on August 11, 2016.
Non-Performing Assets (NPA)
RBI continues to be firm on non-performing assets (NPA). Many banks have already taken an early call, and are working on it. Overall stressed assets have no acceleration and the pace of NPA has de-accelerated. “In coming quarters better results are expected to be seen,” said Mundra, the Deputy Governor of RBI.
Retail inflation was on a 22-month high to 5.77 percent in June, which is one of the major concerns of the central bank. The inflation was driven mainly by food, especially vegetables and sugar. This spike in inflation reversed the declining graph that was observed in the first two quarters of the year. The housing allowance by the Seventh Pay Commission is expected to contribute to the trend. However, it may not have a long-term impact. It is also believed that GST implementation will lead to inflation. However, it will be premature to discuss inflationary impact till rates are not decided. If we take the example of other countries, like Malaysia, GST did lead to inflation, but it had a short lived impact. The RBI has maintained its inflation targets at five percent, hoping the food inflation to come down owing to the good monsoon predicted this year.
Economist had concerns regarding the maturing of the $20 billion worth of FCNR starting next month. This was believed to be one of the reasons behind the modest rates passed on by banks. Rajan confirmed that RBI will stick to foreign exchange interventions and domestic liquidity operations to ensure smooth repayments. The central bank has been injecting liquidity in the economy through open market operations (OMOs) and spot deliveries of forward purchases.
Current Economic Conditions
Since the second bi-monthly statement announced in June, several developments have clouded the outlook for the Indian economy. Several factors are helping to support the recovery. After a delayed onset, the south-west monsoon picked up from mid June. By early August, the cumulative rainfall was 3 per cent higher than the long period average. Also, more than 80 per cent of the country received normal to excess precipitation.
Industrial production picked up in May due to manufacturing and mining, following a contraction in the preceding month. It has steadily been increasing since then. On the other hand, the pace of growth of consumer durables has been stable and buoyed by urban consumption demand. Service sector purchasing managers polled the thirteenth successive month of expansion in July basis of a sharp acceleration in new business this year.
The Road Ahead
The recent sharper-than- anticipated increase in food prices has pushed up the projected trajectory of inflation over the rest of the year. The prospects for inflation excluding food and fuel are more uncertain. Therefore, risks to the inflation target of 5 per cent for March 2017 continue to be on the upside. RBI feels the momentum of growth is expected to increase by the normal monsoon raising agricultural growth and rural demand. Also, stimulus to consumption spending can be expected from the disbursement of pay, pension and arrears following the implementation of the Seventh Pay Commission.
The Goods and Services Tax (GST) Bill augurs well for the growing political consensus for economic reforms. Although timely implementation of GST can be challenging, there is no doubt that GST will raise returns to investment across much of the economy. It will also strengthen government finances over the medium-term. The current accommodative stance of monetary policy and comfortable liquidity conditions is expected provide a congenial environment for the reinvigoration of aggregate demand conditions.
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