5 key takeaways from RBI's policy review

Even as the Reserve Bank of India (RBI) kept key rates – the repo rate, reverse repo rate and the cash reserve ratio (CRR) – unchanged at its Fifth Bi-monthly Monetary Policy review on Tuesday, inflation continued to remain one of the key factors that the central bank will monitor for further rate cuts. It, however, reiterated its accommodative stance while reviewing policy rates going ahead.

"We believe that the RBI views Pay Commission implementation to be the biggest risk to fiscal deficit and hence inflation via increase in wages and rents, and thus may like to wait for government's guidance on the same in the Union Budget in February 2016, before cutting rates any further," said Jay Shankar, chief India economist & director, Religare Capital Markets.

Here are 5 key takeaways from RBI’s Monetary Policy review:

Focus on Inflation: As was the case with earlier policy reviews, (consumer price) inflation still remains a key monitorable and the core factor as regards the RBI’s roadmap for future rate cuts. It expects the inflation to rise till December before plateauing. 

“While oil prices, barring geopolitical shocks, are expected to remain benign for a few quarters more, the uptick of CPI inflation excluding food and fuel for two months in succession warrants vigilance,” the RBI said.

7th Pay Commission impact: Another key monitorable for the central bank is the likely impact of the recently announced proposals of the 7th Pay Commission that seek to hike the salary, allowances and perks of central government employees and pensioners by a huge 23.55%. 

“The implementation of the Pay Commission proposals, and its effect on wages and rents, will also be a factor in the Reserve Bank’s future deliberations, though its direct effect on aggregate demand is likely to be offset by appropriate budgetary tightening as the Government stays on the fiscal consolidation path,” the policy statement said.

Outlook for agriculture and rural demand: While the RBI sees an uptick in the urban demand, it remains concerned regarding the outlook for agriculture and a weak rural demand. While urban consumption is showing signs of a pick-up in some areas such as passenger vehicles sales, the RBI says, rural demand has been weakened by two consecutive deficient monsoons and slowing construction activity. 

“The outlook for agriculture is subdued, in view of both rabi and kharif prospects being hit by monsoon vagaries,” the RBI said in its review.

Commodity prices: Emerging market economies (EMEs) continue to face headwinds from domestic structural constraints, shrinking trade volumes and depressed commodity prices. Given this backdrop, the RBI plans to follow developments on commodity prices, especially food and oil, even while tracking inflationary expectations and external developments.

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Policy transmission and base rates: Despite the 125 basis point (bps) rate cut by the central bank in calendar year (CY) 2015, banks have transmitted less than half of the cumulative policy repo rate reduction. Given this, the RBI is likely to finalise the methodology for determining the base rate based on the marginal cost of funds, which all banks will move to. 

“The Government is examining linking small savings interest rates to market interest rates. These moves should further help transmission of policy rates into lending rates. In addition, the on-going clean-up of bank balance sheets will help create room for fresh lending. The Reserve Bank will use the space for further accommodation, when available, while keeping the economy anchored to the projected disinflation path that should take inflation down to 5 per cent by March 2017,” the central bank said.