5 key takeaways from the RBI's Monetary Policy review

As widely expected, the Reserve Bank of India (RBI) kept key rates – repo, reverse repo and the cash reserve ratio (CRR) – unchanged in its sixth bi-monthly monetary policy review on Tuesday. The central bank, however, remained committed to an accommodative stance on rates.

"The RBI has kept the policy rates unchanged. The risks to the glide path of inflation seems to be balanced as of now. However, the RBI does mention the 7th Pay Commission risks to the fiscal deficit, which they have not factored in their inflation trajectory. So, the RBI is in ‘wait-and-watch’ mode as to what North Block does in the Union Budget and what big states are doing with their own state pay commissions," said Jay Shankar, Chief India Economist & Director, Religare Capital Markets.

 

"As per our estimate, the Pay Commission implementation by the Centre and state govts. would lead to a $50 billion fiscal stimulus over the next two years. The downside risks emanate from softer global commodity prices and a normal monsoon. However, the RBI would like to wait and watch as these factors play out over the next few months before being in a position to recalibrate the glide path of inflation and respond accordingly. We believe that the upside risks are marginally higher than the downside risks as of now, and hence we do not see any policy rate cuts in FY17," he adds.

"The policy re-affirms our view that RBI will likely act after factoring in developments stemming from the Union Budget. We expect 25 bps rate cut in the April policy assuming (1) qualitative expenditure mix even if the government factors in 7th Central Pay Commission recommendations, and (2) January 2016 inflation drops below RBI’s estimate of 5.8-6.0% (Kotak: 5.6%)," points out Upasna Bhardwaj, an economist with Kotak Institutional Equities in a note.
 

Here are 5 key takeaways from the RBI's sixth bi-monthly monetary policy review:
 

Onus on government / upcoming Union Budget 2016: While maintaining a status quo on rates, the RBI has clearly put the onus on the government to maintain fiscal prudence while unveiling the policies in the Union Budget 2016. 

"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% by the end of 2016-17," the RBI statement says.

7th Pay Commission impact: Though the RBI remains hopeful that inflation will remain under check, it has not factored the impact of the 7th Pay Commission in its inflation forecast. The RBI expects the 7th Central Pay Commission award to impact inflation for one - two years. 

"The implementation of the VII Central Pay Commission award, which has not been factored into these projections, will impart upward momentum to this trajectory for a period of one to two years. The Reserve Bank will adjust the forecast path as and when more clarity emerges on the timing of implementation. Vagaries in the spatial and temporal distribution of the monsoon and the impact of adverse geo-political events on commodity prices and financial markets add additional uncertainty to the baseline," the RBI statement said.

Inflation: Inflation still continues to be a key monitorable for the RBI and the central bank expects it to be around 5% by the end of fiscal 2016-17. 

"Inflation has evolved closely along the trajectory set by the monetary policy stance. With unfavourable base effects on the ebb and benign prices of fruits and vegetables and crude oil, the January 2016 target of 6% should be met," the RBI statement said.

Growth trajectory: The RBI expects growth to accelerate gragually going ahead despite significant headwinds. Expectations of a normal monsoon after two consecutive years of rainfall deficiency, large positive terms of trade gain, improving real incomes of households and lower input costs of firms are some of the factors according to the RBI that should contribute to strengthening the growth momentum.

The central bank, however, renains concerned regarding weak domestic private investment demand, re-emergence of concerns relating to stalled projects, excess capacity in industry, sluggish external demand conditions dampening exports, and lists them as key headwinds that could hamper this growth.

Focus on Start-ups and ease of doing business: The central bank has also emphasised the need for ease of doing business, in line with the Government's Start-up India initiative and plans to contribute to an ecosystem that is conducive for growth of start-ups. 

"These measures will create an enabling framework for receiving foreign venture capital, differing contractual structures embedded in investment instruments, deferring receipt of considerations for transfer of ownership, facilities for escrow arrangements and simplification of documentation and reporting procedures. A detailed statement is being issued separately," the RBI statement said.