The job of a flight pilot and that of the RBI Governor is quite similar. They are the ones that have to run the show—irrespective of foggy or clear skies. At present, the Indian economy is passing through the clouds of uncertainties. Unfortunately this time it is denser than one would imagine. Now, the job of the RBI Governor is to not only land the flight of the Indian economy safely, but to also ensure a smooth landing, avoiding any chance of post-landing accidents. So it’s a team effort between the Government and the RBI. The role of the Government, like the Air Traffic Control and ground staff, is very crucial as it has to do all the groundwork, provide accurate and timely signals, and clear up the runway for a smooth landing. The RBI has already done its job and is now waiting for the Government to play its part.

In the case of the sixth bi-monthly review of monetary policy, the RBI has maintained the policy rates unchanged.

The backdrop...
The decision of the Central bank to keep policy rates unchanged comes from the history of slower global growth and falling commodity prices. Since the fifth bi-monthly monetary policy review statement released in December 2015; the growth in the emerging world economies has weakened in contrast to the small improvements witnessed in the advanced economies. The sharp fall in crude oil prices and tanking growth in the Chinese economy have been the bad news in particular.

Back home, the economic growth is plagued by slower industrial activity and dipping agricultural output. The performance of the agriculture sector is challenged by deficient North West Monsoon. To add to worries, India has received North East monsoon 23% lower than the average over a longer duration. As a result, the sowing of the Rabi crop has been a tad lower compared to the 5-year average.

On the other hand, the industrial growth is severely constrained by weaker investments and a lack of capacity utilisation. The Capital goods sector has reported deceleration and the lacklustre construction activities show a very high number of projects stalled.
 

After the latest policy review:

• Repo rate under the liquidity adjustment facility (LAF) stands unchanged at 6.75 per cent
• Cash reserve ratio (CRR) of scheduled banks remains unchanged too at 4.0 per cent of net demand and time liability (NDTL)
• In future, the RBI will continue to provide liquidity under overnight repos at 0.25 per cent 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 per cent of NDTL of the banking system through auctions
• RBI will continue with daily variable rate repos and reverse repos to smooth liquidity

 

What to expect?
The monetary policy of the RBI is likely to remain accommodative. However, further rate cuts are contingent upon inflow of the inflation data. The RBI seems to be satisfied with the progress of banks in tackling the problem of Non-Performing Assets (NPAs). It believes that the Government’s commitments on infusion of capital in Public Sector Banks (PSBs) will place the adequate capital in the right hands. More capital allows banks to absorb higher losses, if any. Additionally, the RBI is figuring out innovative ways to tackle the systemic problem of bad loans. Once the health of banking sector improves, credit disbursement may happen more effectively. Nonetheless, the effective transmission of rate cut benefits that have already been accorded remains the prerequisite for future rate cuts.

As described by RBI, “The Indian economy is currently being viewed as a beacon of stability because of the steady disinflation, a modest current account deficit and commitment to fiscal rectitude. This needs to be maintained so that the foundations of stable and sustainable growth are strengthened.”

When asked by the media about what fiscal deficit numbers will look like in the coming budget, the RBI Governor avoided providing any specific figure. Instead, he advised that the budget should be looked upon as a package. PersonalFN believes by doing this the RBI has discouraged any speculation building up around the fiscal deficit number. Interestingly, this statement conveys something more. When RBI describes the budget as a “package”, avoiding any comments on any specific fiscal deficit number, it cautiously welcomes the predictable and planned increase in Government’s spending. If the Government spends more for turbocharging economic growth, the RBI may not mind it. But if it spends extravagantly on populist schemes, keeping in mind forthcoming elections, it may not go down well with the Central Bank.

This means the RBI will carefully track the forthcoming Union Budget 2016-17 before it decides anything on policy rates in future.

Why has the RBI preferred to keep rates unchanged despite of sluggish growth?
From the RBI’s point of view, the adverse base effect has affected industrial growth numbers. To comprehend this better, here’s the explanation. Generally, the industrial growth numbers are calculated for a specific time period in comparison to the same time period of the previous Financial Year (FY). The growth for January 2016 will be calculated relative to the growth recorded in January 2015.

The RBI expects the Indian economy to grow at 7.4% in the current financial year, but it remains worried about the possibility of downward revisions. However, it is more optimistic about the projected growth prospects for the next fiscal (i.e. 2016-17), as it expects India to grow at 7.6%. The RBI opines that the Indian economy is set to attain higher industrial and economic growth in FY 2016-17. The expectation of a regular monsoon, strong trade position on the import-export front, and potential improvement in real household incomes bode well for the rationale of higher economic growth.

As for the question of inflation, the RBI appears to be satisfied with the way things have panned out; and giving itself the flexibility to make revisions in the inflation expectation, it has exuded confidence about achieving the target of 5.0% by the end of FY 2016-17. That being said, the Central Bank has warned against the immense inflationary pressure building up in segments such as, housing, transportation, education, and healthcare to name a few. It still hasn’t factored in the impact of the 7th pay commission provisions in inflation projections. Contrary to expectations, if the monsoon turns out to be subdued this year, inflation is likely to become a bigger challenge.

Key takeaways...
Having played its part by providing an accommodative policy stance, taking corrective measures to improve the health of banks, and supporting various initiatives of the Government by making changes to the existing regulatory framework, the RBI now awaits the Government’s move.

The Government has to address a diverse range of issues, it can’t just focus on the industry and financial markets. Similarly, it can’t spend excessively on social schemes ignoring fiscal prudence, it has to think about all sections of the economy. Since the RBI has been repeatedly expressing its worries against growing inflation in services; you may expect the Government to address these concerns. Spending on education, healthcare, and affordable housing might go up significantly. Skill development programmes that directly affect the employability of people, which in a way affects their purchasing power, may also see greater budgetary allocations. Therefore expect the Government to resolve the problems you face every day.

If the Government achieves any success in passing the Goods and Services (GST) bill in the Rajya Sabha at the upcoming budget session, it will positively curb inflation. Higher inflation expectation among households results in softening of demand. Unless demand picks up, underutilisation of production capacities will continue to hamper the prospects of industrial growth.

Impact on markets
Although the equity market still looks weak, it was the least affected by the latest policy action of RBI. High valuations and lack of growth in corporate earnings have been the main reasons for the market rout.

Speaking of debt markets, the expectation of a rate cut were not very high this time, hence yields have remained steady after the RBI maintained status-quo on the policy rates. The upcoming budget is likely to have more impact on the markets.

There were few concerns over the liquidity in the markets before the monetary policy was announced. Markets were keen to know the RBI’s view on the liquidity condition in the system. The average daily liquidity injection (including variable rate overnight and term repos) had increased from Rs 1.2 lakh crore in December to about Rs 1.35 lakh crore billion in January. In addition, the Reserve Bank had also injected Rs 20,000 crore through open market purchase operations on December 7 and January 20.

The RBI has assured the use a range of instruments to ensure liquidity is not constrained in the future. It sees no stress on the liquidity front as of now as the call money rates are pretty close to the repo rates. As a result, short term rates are likely to remain steady, however, you may see some volatility in the long-term yields as markets await clarity from the Government on matters such as fiscal deficit and budgetary support to growth. The Government’s effort in addressing the services sector inflation will also be crucial from the market’s perspective.

To conclude in one line, the RBI wants to see the Government’s commitment to growth before signaling more cuts in the borrowing cost.

Let’s hope for clearer skies and a safe landing.
 

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