Easy stance on liquidity: Gaurav Kapur

The Reserve Bank of India (RBI) has decided to adopt an accommodative stance on liquidity in the banking system to match its policy rate stance. Its actions indicate that room for further cuts is significantly constrained. Monetary transmission for a cumulative rate cut of 1.5 per cent since 2015 needs to be pushed through, with easier liquidity conditions. RBI's assessment of inflation also limits the rate-cut possibility. With a one to 1.5 per cent increase in Consumer Price Index (CPI)-based inflation because of the Seventh Pay Commission over the next two years, rate cuts would be limited. A deficient monsoon will also push up inflation. Keeping inflation at the desired level will be a challenge, but the focus has to be on providing liquidity through durable means. The main reason why policy rate cuts (1.25 per cent) did not pass into lending rates (0.53 per cent) was RBI's preference for deficit liquidity and, since mid-December, it has been larger than the central bank's target. Now, RBI would have to inject fresh liquidity of up to one per cent of the net demand and time liabilities for policy rate cuts to pass into lending rates.

Gaurav Kapur
Senior economist, Royal Bank of Scotland