India: Central Bank leaves rates unchanged, still prudent regarding the disinflation process
August 5, 2014
At its 5 August monetary policy meeting, the Reserve Bank of India (RBI) decided to leave the repurchase rate unchanged at 8.00%, which was in line with market expectations. In addition, the Bank left the reverse repo rate at 7.00% and the marginal standing facility rate at 9.00%.
The Bank acknowledged an increase in investor appetite for risk regarding investments in the emerging market economies. This is mainly supported by improved liquidity conditions stemming from the continued support from monetary policy to the main developed economies. While the RBI saw this as a positive development, it also warned that the situation leaves the recipient countries increasingly exposed to changes in the appetite of foreign investors.
Regarding the situation in the domestic economy, the Bank sees a revival in industrial growth and exports, whereas the leading indicators in the service sector are showing “mixed signs.” Overall, the bank highlighted two points that suggest an optimistic outlook for economic growth. First, the role of the new government policy actions, which, “should create a congenial setting for a steady improvement in domestic demand and supply conditions.” Second, while the RBI sees the government intentions to improve efficiency in the supply chain of the food sector, the Bank also said that the concerns about the effects of the monsoon on agricultural production have been mitigated, but not completely dispelled.
Therefore, the RBI is still vigilant on the possible impact of the monsoon in food prices. Despite that CPI inflation eased in May and June, the Bank said that it is too soon to, “conclude that future food inflation, and its spillover to broader inflation, can be discounted.” In fact, July’s inflation (which was released after the RBI’s bi-monthly statement) confirmed the Bank’s suspicions. Consumer prices rose again in July to an annual rate of 8.0%, up from June’s 7.5%, which had marked a more than two-year low. In addition, the RBI stated it will remain vigilant as there are several factors that can affect the outlook for inflation, such as current international geopolitical tensions, pass-through effects of the rise in some of the administered prices and continuing uncertainty over monsoon conditions.
Given its assessment of the economic situation, the RBI considered it appropriate to remain put and leave the main reference rates unchanged. That said, it pushed additional measures to foster economic growth. The RBI reduced the statutory liquidity ratio (SLR) for banks for the second consecutive meeting. This move is intended to foster credit and improve liquidity conditions given that the newly elected government has committed to fiscal consolidation, which leaves the door open for credit expansion to the productive sectors. Regarding these additional measures, Kritika Kashyap and Kewei Yang, Economists at Morgan Stanley, point out that:
“Although the RBI’s flexibility to cut policy rates is limited by the inflation outlook, the central bank is doing what it can to support growth. The RBI cut SLR rates by 50bp and lowered the hold-to maturity ceiling to 24% at the August 5 meeting. While banks continue to hold more than the required SLR limit in government bonds, by relaxing the obligation to hold these bonds, the SLR cut frees up capital for lending as and when credit demand increases.”
Finally, the RBI restated its projection of GDP growth of 5.5% within a likely range of 5.0% to 6.0% for FY2014/15. In addition, the Bank said it remains committed to the disinflationary path of taking consumer price inflation to 8.0% by January 2015 and to push it further down to 6.0% by January 2016. The next monetary policy meeting will be held on 30 September.