Run Up to the 6th Bi – Monthly Monetary Policy

The Reserve Bank of India, will announce its first bi monthly monetary policy of the year on Feb 2,2016. It will be interesting to see Dr. Rajan’s decision on the policy rates. Will it be a rate cut, a status quo or a rate hike in anticipation to the current economic and global conditions? Lets analyse based on a set of parameters and global economic scenario. In this blog, we will take a quick look at the macro economic indicators of inflation, growth and financial stability. We will also access the global conditions in relation to such relevant parameters. Currently, the repo rate is 6.75%, CRR fairly steady at 4% and SLR at a reasonable lower levels of 21.5% compared to the year 2013.

Recently, in its last monetary policy, the Federal Reserves decided to raise its interest rates after 7 consecutive years of near zero interest rates. Although, the decision was anticipated, the effects of the same will be felt by the global economy in terms of further slowdown. The rise in the fed rates, will be something significant for the RBI to consider before it takes any action in the sixth bi-monthly monetary policy.

The RBI in its policies so far, has been easing the policy stance from Jan 2015 with the intention of fostering growth of the real economy. RBI till its fifth monetary policy statement was quiet positive on the growth especially with a hint of an uptick in the manufacturing sector. With that hope, it had also kept its GDP expectations unchanged in its previous review. However, much has changed since then. The Indian economy has slowed down sharply towards the end of 2015. 

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With the growth slowing down in the coming quarters, RBI might re-look at its estimates in the upcoming monetary policy. Index of Industrial production has reduced from the 5% levels of July-August quarter down to 3.5% in the Sept-Nov. IIP in Nov has shown a sharp decline Month On Month with the manufacturing sector and infrastructure slowing down. PMI indices of manufacturing and services have also indicated a reasonable amount of contraction, for the RBI to worry about. 

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The inflation scenario, too, has started worsening from the past 5 months. While the headline CPI inflation is headed northwards with an uptick in the food inflation and core inflation figures. The food inflation might further intensify in the coming months the constant stress on agricultural produce due to back to back droughts, unseasonal rains and relatively warmer winter impacting the rabi crops. On the fiscal front, the indication of a seventh pay commission and the further implementation of the same in the upcoming budget might add to the inflation further. However, these effects will be transitional rather than structural. With CPI inching upwards, WPI has shown an increase as well. Although, WPI is still suggesting deflation, the rate of deflation has sharply slowed down from the past 3 months. 

Note for the readers: Food inflation and core inflation form the basics of the CPI inflation figures in India. While the food inflation indicates the inflation of food items such as vegetables, pulses, fruits, milk,eggs etc, the core inflation indicates the inflation related to non food and non fuel items.

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Food Inflation
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On the banking front, RBI has been facing issues in the implementation of effective monetary policy transmissions. Despite RBI reducing the repo rates to the tune of 125 bps, bank’s base rate have reduces only by 55-60 bps. Apart from that, the pressures of non performing assets are mounting. However, the new base rate formula calculation might act as a catalyst towards the reduction in the base rate. In addition to the current scenarios, the deposit growth has been at par with credit growth which is a relief to the RBI so far. The credit growth has picked up lately as the lagging effects of the policy easing.

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Credit Growth Trend
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Average Base Rate

Currency markets have been highly volatile lately, in the wake of unrest in the major global players. Rupee has been sloping downwards compared to the dollar in the past six month. Dr. Rajan has however managed to control that volatility by selling millions of dollars in Oct-Dec quarter. RBI would atleast not reduce its interest rates in the near future, in order to stop the rupee from sliding further. However, the good part is rupee has performed extremely well in comparison to the other emerging economies. Considering the CPI at 6% and the repo rates at 6.75%, ERI is hovering around 0.75-1% which might affect the growth in the coming future. However, RBI would still be focusing on reducing the inflation and retaining the financial stability before any further easing. On the global front, RBI would want to keep its stance as is and be a star performer in contributing to the global growth compared to the other economies. India, might grow at close to 7-7.2% this fiscal year look at the current conditions. Due to the interest rate hike, the FPIs have pulled out more than 9500 Cr from the Indian equities on global worries. That has undoubtedly led to ongoing volatility in the Indian financial markets. 

What does all of this mean for the upcoming monetary policy?

There is no doubt that economic slowdown has become acute in the recent month. But the same has happened despite significant easing from Jan 2015. Certainly, the solution does not seem to lie in the monetary sphere this time. I predict, that the RBI might hold the repo rates at the current levels of 6.75%.CRR and SLR might also be untouched due to the ample amount of liquidity and money supply in the system. However, the tone of the policy would continue to be fairly dovish . The RBI might re-look at the GDP forecast and reduce it from the current forecast of 7.4% to 7-7.2%. However, RBI will keep its consistent focus on the inflation control and financial stability goals by maintaining an orderly depreciation in the currency and stable interest rates. 

Thank you. 🙂