The Reserve Bank of India (RBI) on Tuesday kept its policy rates unchanged, choosing instead to wait for signs of expenditure control and structural reforms in the coming Budget.
RBI Governor Raghuram Rajan gave enough indications that the ball was now in the government's court. In his press conference, Rajan stressed that monetary policy can achieve "only so much" for growth. Another nudge came in the form of a reminder that fiscal rectitude is important for preserving macro stability. The policy statement stated that India was being viewed "as a beacon of stability because of the steady disinflation, a modest current account deficit and commitment to fiscal rectitude". The statement also suggested that "controlling spending will create more space for monetary policy".
RBI will also keep an eye on how the Seventh Pay Commission recommendations are implemented and expects the wage hike for government employees to have an impact on inflation in the next one or two years.
Following the status quo in its sixth bi-monthly monetary policy review, the repo rate, or the rate at which the central bank infuses liquidity into the system, remained at 6.75 per cent. The cash reserve ratio (CRR), or the portion of a bank's money maintained with the central bank in cash, remained at four per cent.
A pause in rate cuts was widely expected by the market and the analyst community. A BS poll on the policy had indicated the central bank would not want to take any action on rates before the Budget scheduled for February 29, but could lower rates by 25-75 basis points (a basis point is a hundredth of a percentage point) after the Budget.
RBI also hinted something similar. "The Reserve Bank continues to be accommodative even as it leaves the policy rate unchanged in this review, while awaiting further data on the development of inflation," the RBI said.
"Structural reforms in the forthcoming Union Budget that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5 per cent by the end of 2016-17," the central bank added.
The policy document also iterated the need to revive private investment demand at a time when the business climate was improving and fiscal policy was on the path of consolidation.
Economists agreed with the RBI's stance of putting the onus on the government. "We are broadly in agreement with the RBI that the bulk of heavy lifting in investment needs to be done by the government. While this means an increase in the government's capital expenditure, it is the uncertainty related to the fiscal consolidation path and the consequent reduction in revenue expenditure that it subsequently entails that makes the RBI hesitant to act at this juncture," said Abheek Barua, chief economist, HDFC Bank. Standard Chartered Bank sees the upcoming Budget as crucial as increased claims on government finances and slow economic growth could pose challenges for the government to meet its fiscal deficit target.
"In February 2015 the government recalibrated its fiscal consolidation path and delayed the fiscal deficit target of 3 per cent by a year to 2017-18," said Anubhuti Sahay, chief economist of Standard Chartered Bank, India. Retail inflation as measured by the Consumer Price Index was 5.61 per cent in December, lower than the RBI's expectation of 6 per cent by January 2016. However, the index of industrial production (IIP) shrunk to 3.2 per cent in November, raising expectations that the RBI would, sooner or later, have to ease its policy rate.
The RBI expected Gross Value Added (GVA) growth, the new methodology of calculating economic progression, at 7.4 per cent in 2015-16 and 7.6 per cent in 2016-17. In 2016-17, growth would strengthen gradually, "notwithstanding significant headwinds", led by an expected normal monsoon, large positive terms of trade gains, improving real incomes of households and lower input costs of firms, the central bank said.
"Yet, still weak domestic private investment demand in a phase of balance sheet adjustments, re-emergence of concerns relating to stalled projects, excess capacity in industry, and sluggish external demand conditions damping export growth could act as headwinds," the policy said.
Overall, the current pace of growth was "reasonable", but below what should be expected over the medium term, the policy document said, adding, growth drivers needed to be rekindled to place the economy durably on a higher growth trajectory. Banks remained non-committal on further rate cuts, but the RBI expects the new methodology of calculating the lending rate, as well as emergent competition, will force the lenders to pass on cut in policy rates eventually.
"Marginal cost loan pricing that will kick in from April 1 will actually help in transmission. It will be an improvement over the earlier base rate. We will see a significant change in the transmission process when that happens," Rajan said. The government's capital support to banks was adequate, Rajan said in his post-policy interaction with the media. "The finance minister has indicated he will support the PSBs with capital infusion as needed. Our estimate is that the support that has been indicated will suffice," Rajan said. The central bank will continue to monitor inflation and provide liquidity support even if that means the RBI's own restriction of keeping liquidity shortage within 1 per cent of net demand and time liabilities (NDTL), or roughly the total deposit base, is breached.
The average daily liquidity injection increased from Rs 1.2 lakh crore in December to about Rs 1.345 lakh crore in January. In response to the policy, the Sensex fell 1.15 per cent to 24,539 points, the Nifty fell 1.33 per cent to 7,455.55 points, bond yields rose 6 basis points to 7.85 per cent and the rupee weakened to 67.98 a dollar from its previous close of 67.84.
|WHAT RAJAN EXPECTS FROM JAITLEY'S BUDGET|
Issues like single-window clearance for projects, better management of environment clearances, coal and gas linkages, power sector reforms are pending
In February 2015, the govt delayed reaching its fiscal deficit target of 3% by a year to FY18. RBI would be looking at both the quality and quantity of spending
REVIVAL OF PVT INVESTMENT
According to CMIE, stalled projects in Q3 FY16 amounted to Rs 10.7 lakh crore, even as fresh capex investment saw a steady fall
REVIVAL OF STALLED PROJECTS
Projects are stalled and a slow recovery of the economy is not generating demand fast enough
PAY PANEL IMPLEMENTATION
Seventh Pay Commission recommendations would widen the fiscal deficit and push inflation over the next two years