Fourth Bi-Monthly Monetary Policy – Expectations v/s Reality

The Reserve Bank of India will be rolling out its fourth monetary policy review for the year on 29th Sept,2015. The opinions so far are mixed in nature about whether RBI will choose to maintain status quo or cut rates for the fourth time in a year. Although, the markets seem to expect a rate cut of 25 bps, Dr. Rajan will have his own judgement of the situation. Let us understand what the various domestic macroeconomic indicators and the global events suggest. We will also briefly discuss about the FOMC meeting held on 16th and 17th Sept and its outcome. We will evaluate the domestic factors such as CPI, WPI, IIP, Credit Growth, Deposit growth, call money rates for liquidity, stability of rupee, global data, and finally ERI (Equilibrium Real Interest being the factor that decides the quantum of a rate cut, if at all there will be one).

For the readers ready reference, the following link will give you an idea as to what we predicted in the third bi-monthly monetary policy:

Third Bi Monthly Policy

The overall signals from the global events indicate that the global growth is slowing down. China being the predominant contributor in the same. Euro zone, is still struggling with the deflationary scenario. ECB, in its recent monetary policy review, kept its rates unchanged at 0.05% and decided to continue with the ongoing monetary stimulus in the form of Quantitative Easing. Federal Reserve, on the other hand, also decided to maintain status quo in their policy review. US Fed briefly decided based on two important factors, namely, unemployment data and retail inflation. The unemployment data was below the 5% target levels of Fed but inflation still showed persistence at near 0% levels. The FOMC implements its policies based on FIT( Flexible Inflation Targeting). With such disappointing data, Fed hence decided not to hike the rates and maintained a status quo at 0-0.25% rates, which indirectly has given a room for a repo cut.

IIP data, published for the month of August, showed a sharp rise to 4.2%, which clearly suggests that a rate cut might not be required when the manufacturing sector has expanded well. IIP was majorly driven by manufacturing, electricity and surprisingly agriculture as well. WPI, on the other hand, continued its downward deflationary trend and stood at -4.95% as compared to near -4% levels last month. Looking at WPI as a stand alone data, its does indicate the required room for a 25bps rate cut. CPI, the retail inflation indicator, which is an indicator that RBI monitors closely before a monetary policy review also eased to 3.66% from 3.69% (july) in August. Although, the CPI seems to be eased, it is suggested by the RBI that the fall was largely due to the base effect, excluding which it would be around 5.5%. Overall, CPI numbers are suggesting a rate cut, but my take is that the base effect will play a major role in deciding the actual values. The trajectory of CPI in the future seems to have upside and if not tamed, RBI might miss its sub 6% inflation targets by Jan 2016.

CPI Inflation Trajectory so far...
                                                            CPI Inflation Trajectory so far…

The banking sector seems to be struggling in its growing NPA numbers and higher cost of funds. Credit growth (9.8%) is still being outpaced by deposit growth (11.56%) which is a cause of worry for the banking business. RBI, with its draft guidelines on moving to Marginal Cost of Funding from the old system of Average Cost of Funding, has suggested the banks to not rely solely on rate cuts for reducing the costs. RBI has also rolled out a few reforms for efficient lending and management of NPAs in the past few months. Recently, to facilitate the corporates, it also liberalized the External Commercial Borrowings norms.

We have to expand the sustainable growth potential. That means continuing to implement reforms that the government and the regulators have announce. That is the only way to get sustainable growth potential up – Dr. Raghuram Rajan

With the call money rates at 7.28%, which are well within the repo window of 6.25% and 8.25%, the liquidity condition seems to be quiet comfortable and certainly rules out any chances for further monetary easing. Rupee in the past two months has depreciated by about 3% amidst yuan devaluation. Maintaining the stability of rupee is a challenge for the RBI and any further easing might lead the rupee to depreciate further. Although, India has fared well against the other countries in the emerging economies group, its is unlikely that the RBI would be comfortable allowing the rupee to depreciate further. On a quantitative note, as I mentioned in previous blogs, RBI is comfortable with an Effective Real Interest rate of 1.75% over and above the average inflation. The average inflation in India for 2015 is at 5.96%. Adding the ERI to the inflation, it is unlikely that there is any room for rate cuts.

While fellow BRICS (Brazil, Russia, China and South Africa) were in distress, India has seemed to be an “Island of Tranquility” – Dr. Rajan

Summarized Parameters
  Summarized Parameter Indications

The parameters, which are predominantly domestic, as mentioned in the above given image suggest that the RBI should probably wait a little longer on their decision to cut rates. Although, the ‘FED’ maintained a status quo, it is likely that they might raise the rates by Dec 2015 if the data is supportive enough. The RBI is likely to maintain a status quo and pass on the next set of triggers on to the Government reforms, since the RBI has indicated that they will focus on long-term inflation targeting rather than quick impatient fixes for the economy. RBI would be happy if the growth path hereon can be spearheaded by the reforms with respect to the GST and its smooth functioning in ease of doing business. However, after analyzing the relevant factors, in terms of magnitude and direction, I predict that the RBI might choose to maintain the status quo at 7.25% in the Fourth Bi-monthly monetary policy. CRR and SLR ratios are also likely to be untouched as the liquidity conditions are surplus. 

Thank you 🙂   


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Akshay Baregar

A hardcore analyst who loves to read about finance, upcoming concepts, ​and their applicability. Have always wanted to become an analyst and been thinking like one from the recent past. This is my attempt to write and make the world around me aware of the financial happenings and the likely impacts/ effects on the Indian/Global Economy. My favourite topics are monetary policies, fiscal reforms, market movements, predictions, wealth management etc . Hoping for an excellent response and feedback from the readers.

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