RBI cuts repo rate by 25 bps

RBI reduces GDP growth forecast to 7.6% from 7.8% in April 2015

The Reserve Bank of India (RBI) has announced the second bi-monthly monetary policy review, announcing the reduction in repo rate by 25 bps to 7.25%.

Highlights

* Reduce repo rate by 25 bps to 7.25%

* CRR unchanged at 4.0%

Assessment

* Global recovery is still slow and getting increasingly differentiated across regions.

* Global financial markets have also been volatile, with risk-on risk-off shifts induced by changing perceptions of monetary policies in the advanced economies.

* Global currency markets continue to be dominated by the strength of the US dollar

* CSO has revised downwards estimate of India's gross value added (GVA) for 2014-15 by 30 bps from the advance estimates.

* Domestic economic activity remains moderate in Q1 of 2015-16.

* Unseasonal rains impacted estimated 94 lakh hectares of area sown under the rabi crop, third advance estimates indicate at a contraction in foodgrains production by more than 5% in relation to the preceding year's level.

* India Meteorological Department (IMD), predicting that the southwest monsoon will be 7% below the long period average.

* Industrial production has been recovering, albeit unevenly.

* The sustained weakness of consumption spending,

* Corporate sales have contracted.

* Capacity utilization has been falling in several industries, indicative of the slack in the economy.

* While an upturn in capital goods production seems underway

* Leading indicators of services sector activity are emitting mixed signals.

* Reduction in the current account deficit resulting from the sharp decline in oil prices has begun to reverse, though the size of the deficit is expected to be contained to about 1.5% of GDP this year.

* 2015-16 has begun with net portfolio outflows in the wake of a reduction in global portfolio allocations to India.

* Foreign exchange reserves are around US$ 350 billion, providing a strong second line of defence to good macroeconomic policies if external markets turn significantly volatile.

Policy Stance and Rationale

* Banks passing past rate cuts, inflation along the projected path, moderate impact of unseasonal rains, muted administered price, and the timing of normalisation of US monetary policy seems to have been pushed back.

* With low domestic capacity utilization, still mixed indicators of recovery, and subdued investment and credit growth, there is a case for a cut in the policy rate today.

* Risks to inflation: IMD predicting a below-normal southwest monsoon, firming up crude prices, and geo-political risks are ever present.

* With still weak investment and the need to reduce supply constraints, a more appropriate stance is to front-load a rate cut.

* Meanwhile banks should pass through the sequence of rate cuts into lending rates.

Projections

* Inflation to be pulled down by base effects till August but to start rising thereafter to about 6.0% by January 2016. IMD's weak monsoon projection and increases in the service tax rate to 14%, the risks to the central trajectory are tilted to the upside.

* Projection for output growth for 2015-16 marked down from 7.8% in April to 7.6% with a downward bias to reflect the uncertainties surrounding these various risks.

* Next policy on 04 August 2015.

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