Tuesday, February 3, 2015

India maintains rate, cuts SLR to boost credit growth

    India's central bank maintained its benchmark repurchase rate at 7.75 percent, as expected, but trimmed the statutory liquidity ratio (SLR) - the amount of bonds that banks must set aside - by 50 basis points to 21.5 percent to create more room for banks to expand credit.
    The Reserve Bank of India (RBI), which cut its rate by 25 basis points less than three weeks ago in an unscheduled move, added that there had been no new developments regarding inflation or the fiscal outlook so it would be appropriate to await such changes and maintain rates today.
    On Jan. 15 RBI Governor Raghuram Rajan had said the key to further rate cuts would be data that confirm continuing disinflation along with sustained fiscal consolidation.
    But Rajan also said that the outlook for growth had improved modestly on the back of disinflation, income gains from lower oil prices, easing financing conditions and progress on stalled projects.
   This should help reinvigorate private demand though the impact on growth could be partly offset by weaker global growth and fiscal consolidation.
    The RBI maintained its forecast for Gross Domestic Product growth for fiscal 2014-15, which ends March 31, at 5.5 percent based on the old GDP basis.
    In the third calendar quarter of 2014, or the second of 2014-15, India's GDP expanded by an annual 5.3 percent, down from 5.7 percent in the second quarter but up from 4.6 percent in the first quarter.
    For 2015-16, the RBI expects to increase its forecast to 6.5 percent growth due to improving domestic conditions, but Rajan added that this could be revised next month following an analysis of the new GDP statistics and advance estimates for 2014-15 on Feb. 9.
    In December India's consumer price inflation rate rose to 5.0 percent from 4.38 percent - a change that Rajan described as "muted" relative to projections - and along with surveys showing falling inflation expectations, weak commodity prices and muted wage growth, the RBI projected it would meet its 6 percent inflation objective by January 2016, spurring the rate cut on Jan. 15.
    With liquidity in India's markets comfortable, Rajan said the RBI would continue the process of moving away from sector-specific refinancing and merge the export credit facility (ECR) with the general system for providing liquidity as of Feb. 7.

    The Reserve Bank of India issued the following statement on monetary policy in its sixth bi-monthly monetary policy statement 2014-15 by its governor, Raghuram G. Rajan:

"On the basis of an assessment of the current and evolving macroeconomic situation, it has been decided to:
  • keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.75 per cent;
  • keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL);
  • reduce the statutory liquidity ratio (SLR) of scheduled commercial banks by 50 basis points from 22.0 per cent to 21.5 per cent of their NDTL with effect from the fortnight beginning February 7, 2015;
  • replace the export credit refinance (ECR) facility with the provision of system level liquidity with effect from February 7, 2015;
  • continue to provide liquidity under overnight repos of 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 7-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and
  • continue with daily variable rate term repo and reverse repo auctions to smooth liquidity.
    Consequently, the reverse repo rate under the LAF will remain unchanged at 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 8.75 per cent.
2. Since the fifth bi-monthly monetary policy statement of December 2014, the International Monetary Fund (IMF) has revised its forecasts for growth in 2015 and 2016 downwards. However, these forecasts are higher than the estimates for 2014. In the United States, growth moderated towards the end of 2014, with the boost to consumption demand from the fall in crude prices more than offset by the drag on net exports from a strong US dollar. In the Euro area, economic conditions have deteriorated in an environment of deflationary pressures, political tensions in Greece and still-elevated levels of unemployment. Demand in Japan is only just beginning to recover from the impact of the consumption tax increase last year, notwithstanding massive monetary and fiscal accommodation. The yen’s depreciation, however, is helping support exports. In China, growth is slowing because of a weakening property market and excess capacity in several industries. This has prompted targeted measures to ease financial constraints faced by corporations and banks. In other emerging market economies (EMEs), growth has weakened sharply for oil exporters, whereas inflationary pressures, subdued investment appetite and a neutral fiscal stance continue to dampen growth in non-oil exporters.

3. The announcement of massive quantitative easing by the European Central Bank (ECB) in late January has reinvigorated financial risk taking, boosting stock markets across the world, even though many market participants have read the softness in crude prices and the ECB’s announcement as signifying a weaker global economic outlook. Along with the growing belief that the US Fed will stay on hold longer than previously thought, bond yields in advanced economies (AEs) have fallen to historic lows. Financial markets remain vulnerable to uncertainty surrounding monetary policy normalization in AEs as well as possibly weaker growth in China and oil exporting EMEs.

4. The revision in the base year for GDP and GDP calculation methods will mean some revision in GDP growth numbers for 2014-15 as well as in GDP forecasts. Domestic activity is likely to have remained subdued in Q3 of 2014-15, mainly reflecting the shortfall in the kharif harvest relative to a year ago. Agricultural growth is likely to pick up in Q4 with the late improvement in the north-east monsoon and in rabi sowing. Nevertheless, growth expectations should be tempered as lead indicators such as tractor and motorcycle sales and slowing rural wage growth all point to subdued rural demand.

5. The improvement in industrial activity in November 2014 was broad-based, but continuing contraction in consumer goods production underscores the persisting weakness in consumption demand (even while raising questions about measurement of production). Advance indicators of industrial activity - indirect tax collections; non- oil non-gold import growth; expansion in order books; and new business reported in purchasing managers surveys - point to a modest improvement in the months ahead. Policy initiatives in land acquisition, as well as efforts underway to unlock mining activity and to widen the space for foreign direct investment in defence, insurance and railways, should create a more conducive setting for industrial revival. Faster clearances are also helping in resuscitating stalled projects. The improvement in business confidence is visible in a pick-up in new investment intentions, especially in transportation, power and manufacturing.

6. In the services sector, the purchasing managers’ survey indicates slower activity, especially in new orders. However, other indicators of the services sector including foreign tourist arrivals, automobile sales, cargo handled at ports, and railway freight traffic suggest improvement. Overall, growth prospects will be contingent upon a turnaround in investment and a durable improvement in the business climate to complement the upsurge in business optimism. The sharp reduction in oil prices as well as in inflation is likely to increase personal disposable incomes and improve domestic demand conditions in the year ahead.

7. Retail inflation, measured by year-on-year changes in the consumer price index (CPI), edged up in December on the expected reversal of favourable base effects that had tempered upside pressures since June. A slight softening of cereal prices and a sharp seasonal fall in vegetables prices moderated the trajectory of headline inflation, despite persistent firmness in the prices of protein-rich items such as milk, meat and pulses. However, seasonal increases in vegetable prices, which typically set in around March, have to be monitored carefully. In the fuel category, prices of constituents such as electricity, coal and cooking gas remained stable in the absence of administered revisions. Consequently, the CPI registered a monthly decline for the first time since February 2014.

8. Inflation excluding food and fuel declined for the second consecutive month in December. This was largely on account of the declining prices of transport and communication since August, reflecting the impact of plummeting international crude oil prices; and softer commodity prices more generally. Inflation in respect of miscellaneous services and housing, however, declined more moderately. Weak domestic demand has restrained corporates’ pricing power and inflationary pressures in the non-food non-fuel category. Near-term as well as longer-term inflation expectations of households dropped to single digits for the first time in 21 quarters. Benign expectations are also mirrored in surveys of professional forecasters and industry conducted periodically by the Reserve Bank.

9. Active liquidity management operations under the revised framework adopted in early September have ensured that liquidity conditions have generally remained comfortable. Money market rates have evolved in close alignment with the policy repo rate, excluding occasional pressures around days of advance tax outflows and quarter-end tightness. Overnight variable rate repo/reverse repo auctions announced early in the day give markets advance intimation of the Reserve Bank’s assessment on system-wide liquidity needs for the day, allowing fine tuning of liquidity. This also reduces the need for other sector specific windows. The average daily net borrowings under the LAF (including term repos, reverse repos and MSF) have been around ` 850 billion in December and January.

10. Easing inflationary pressures strengthened the impact of comfortable liquidity conditions on market interest rates; sovereign and corporate bond yields declined by 50 basis points and more in Q3. However, despite a generalised fall in the cost of funds, banks have yet to pass through these effects, as also the effects of the policy rate cut on January 15, into the spectrum of lending rates.

11. With the slump in international crude prices taking its toll on exports of petroleum products, and non-oil export growth also decelerating sharply, merchandise exports shrank in Q3 of 2014-15 after two consecutive quarters of growth. Export performance has been hamstrung by weak global demand conditions and the persisting fall in unit value realisations. The real appreciation of the rupee may also have had some effect. The fall in international crude prices translated into a sizable saving on account of POL imports, despite a pick-up in import volumes in Q3. Gold imports also moderated, coming off the seasonal cum pent-up demand spurt in September-November. On the other hand, non-oil non-gold import growth remained firm and in positive territory, extending a run that began in May. Although overall imports declined in December, they recorded an expansion for Q3 as a whole on the back of the earlier rise in gold and non-oil non-gold items. As a consequence, the trade deficit widened in Q3 relative to the preceding quarter. The estimate of the current account deficit (CAD) for 2014-15 is currently placed at 1.3 per cent of GDP, significantly lower than earlier projections. The CAD has been comfortably financed by net capital inflows, mainly in the form of buoyant portfolio flows but also supported by foreign direct investment inflows and external commercial borrowings. Accordingly, there was accretion to India’s foreign exchange reserves to the tune of USD 6.8 billion in Q3.

Policy Stance and Rationale
12. By and large, inflation dynamics have so far been consistent with the assessment of the balance of risks by the Reserve Bank’s bi-monthly monetary policy statements, although with some undershooting relative to the projected path of disinflation. While inflation declined faster than expected due to favourable base effects during June- November, the upturn in December turned out to be muted relative to projections. Augmenting these data with survey data on falling inflationary expectations as well as data on weak commodity prices and muted rural wage growth, the Reserve Bank projected that it would meet its objective of 6 per cent CPI inflation by January 2016. Having committed in public statements to initiate a change in the monetary policy stance as soon as incoming data permitted, the Reserve Bank cut the policy rate on January 15, 2015.

13. The Reserve Bank also indicated that “key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation...”. Given that there have been no substantial new developments on the disinflationary process or on the fiscal outlook since January 15, it is appropriate for the Reserve Bank to await them and maintain the current interest rate stance.

14. The upside risks to inflation stem from the unlikely possibility of significant fiscal slippage, uncertainty on the spatial and temporal distribution of the monsoon during 2015 as also the low probability but highly influential risks of reversal of international crude prices due to geo-political events. Heightened volatility in global financial markets, including through the exchange rate channel, also constitute a significant risk to the inflation assessment. Looking ahead, inflation is likely to be around the target level of 6 per cent by January 2016 (Chart 1). As regards the path of inflation in 2015-16, the Reserve Bank will keenly monitor the revision in the CPI, which will rebase the index to 2012 and incorporate a more representative consumption basket along with methodological improvements.

15. The outlook for growth has improved modestly on the back of disinflation, real income gains from decline in oil prices, easier financing conditions and some progress on stalled projects. These conditions should augur well for a reinvigoration of private consumption demand, but the overall impact on growth could be partly offset by the weaker global growth outlook and short-run fiscal drag due to likely compression in plan expenditure in order to meet consolidation targets set for the year. Accordingly, the baseline projection for growth using the old GDP base has been retained at 5.5 per cent for 2014-15. For 2015-16, projections are inherently contingent upon the outlook for the south-west monsoon and the balance of risks around the global outlook. Domestically, conditions for growth are slowly improving with easing input cost pressures, supportive monetary conditions and recent measures relating to project approvals, land acquisition, mining, and infrastructure. Accordingly, the central estimate for real GDP growth in 2015-16 is expected to rise to 6.5 per cent with risks broadly balanced at this point (Chart 2). The revised GDP statistics (base 2011-12) released on January 30 along with advance estimates for 2014-15 expected on February 9, 2015 will need to be carefully analysed and could result in revisions to the Reserve Bank’s growth projections for 2015-16.

16. With liquidity conditions remaining comfortable, the recourse to export credit has been low – less than 50 per cent of the limit on monthly average basis since October 2014. In pursuance of the Dr. Urjit R. Patel Committee’s recommendation to move away from sector-specific refinance, the ECR limit has been gradually lowered since June 2014. Continuing with this rationalisation, it has been decided to merge the facility with system level liquidity provision with effect from February 7, 2015. The Reserve Bank would continue to meet system wide liquidity needs as per the revised liquidity adjustment framework announced on August 22, 2014.

17. In order to create space for banks to expand credit, the SLR is being reduced from 22.0 per cent of NDTL to 21.5 per cent. Banks should use this headroom to increase their lending to productive sectors on competitive terms so as to support investment and growth. "



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