India Monetary Policy April 2016


Reserve Bank cuts repurchase rate, takes steps to boost liquidity

The Reserve Bank of India (RBI) cut the repurchase rate to an over-five-year low and announced a slew of measures designed to boost liquidity amid easing price pressures in the Indian economy. At a scheduled meeting on 5 April, the RBI decided to cut the repurchase rate from 6.75% to 6.50%, a decision which was widely expected by market analysts. However, in an unanticipated move, the Bank decided to narrow the policy rate corridor from plus/minus 100 basis points to plus/minus 50 basis points and consequently cut the marginal standing facility rate (Bank rate) to 7.00% and hiked the reverse repurchase rate to 6.00%. This decision came along with other measures designed to help improve the transmission of policy rate cuts and support growth in India’s economy.

In the accompanying statement, the Bank outlined that the decisions come against a backdrop of subdued global growth characterized by low levels of trade and stress in many emerging market economies. While global financial markets have recouped the losses suffered at the start of the year, the Bank added that an “uneasy calm” prevails which could be dispelled by soft data going forward. Regarding India, the RBI sees growth strengthening slowly in FY 2016 amid a return to normal monsoon, accommodative monetary policy and a salary hike for government employees. Accordingly, the RBI held its GDP growth projection for fiscal year 2016 at 7.6%, with an even balance of risks. The Bank also made no changes to its inflation forecast and stated that prices are expected to move along the projected path and inflation should trend toward the target of 5% by March 2017.

The highlight of the Bank’s statement was the focus on fast-tracking the pace of monetary policy transmission through a number of measures to boost liquidity. Liquidity conditions have tightened in recent months on the back of a slowdown in government spending and capital flows. While previously the RBI had been keeping liquidity in deficit to avoid inflation, an easing in price pressures along with the government’s recent commitment to fiscal targets in the budget for FY 2016 has allowed monetary policy to become more accommodative. Some of the measures announced include narrowing the policy rate corridor, a reduction in the cash-reserve ratio and a move toward a neutral liquidity balance. Commenting on the implications of the announcement, Sonal Varma, economist at Nomura, adds:

“Even as the RBI cut the repo rate by only 25bp, the effective reduction is larger. So far, tight banking system liquidity has meant that the weighted average call money rate is fixed at around 15bp above the repo rate. However, in today’s policy announcement, the RBI has committed to multiple liquidity measures, which will ensure that the weighted average call rate fixes close to the repo rate, ensuring a larger ‘effective’ reduction in the overnight call rate than just 25bp.”

In its forward guidance, the RBI stuck to a dovish tone, maintaining an accommodative stance. The Bank also emphasized that it will continue to “watch macroeconomic and financial developments in the months ahead with a view to responding with further policy action as space opens up.” The next scheduled policy meeting is on 7 June.

FocusEconomics Consensus Forecast panelists are still taking the recent developments into account and project that the repurchase rate will average 6.44% at the end of FY 2016. For FY 2017, panelists also see the repurchase rate ending the year at 6.44%.

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India Monetary Policy Chart

India Monetary Policy April 2016 2

Note: Marginal Standing Facility (MSF) Rate, Repo Rate and Reverse Repo Rate in %.
Source: Reserve Bank of India (RBI).

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