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Update : RBI Cuts Policy Rates
June 2, 2015

Update on RBI Governor's statement on Monetary Policy released on June 2, 2015.

Author : iFAST Research

 RBI Policy Note- Jan15

In the Second Bi-Monthly Monetary Policy review, 2015-16, Dr. Rajan’s thinking seemed to be in line with market expectations. The Governor cut the repo rate by 25 basis points from 7.5% to 7.25% while keeping the cash reserve ratio (CRR) unchanged at 4% of the Net Demand and Time Liabilities (NDTL). The reasons for this decision given by the governor are on these lines:

Banks have started passing through some of the past rate cuts into their lending rates, headline inflation has evolved along the projected path, the impact of unseasonal rains has been moderate so far, administered price increases remain muted, 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.

Yet, of the risks to inflation identified in April, three still cloud the picture. First, some forecasters, notably the IMD, predict a below-normal southwest monsoon. Astute food management is needed to mitigate possible inflationary effects. Second, crude prices have been firming amidst considerable volatility, and geo-political risks are ever present. Third, volatility in the external environment could impact inflation. Therefore, a conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak. With still weak investment and the need to reduce supply constraints over the medium term to stay on the proposed disinflationary path (to 4 per cent in early 2018), however, a more appropriate stance is to front-load a rate cut today and then wait for data that clarify uncertainty. Meanwhile banks should pass through the sequence of rate cuts into lending rates.

From the above statements, it is very clear that although Dr. Rajan has cut the rates today, he is also aware of the risk that persists in the economy. In the policy review, he has emphasized on the fact that the government’s policy will help not only in easing inflation but will also encourage public investment. This will in turn relieve supply constraints and disinflation over the medium term. In short, the governor has made it very clear that monetary policy and government actions should go hand in hand if inflation has to be kept under control.

Our Take

The governor has front-loaded the rates today and has not given guidance on what will be the future course of action. This, in short, means that he will be on a wait and watch mode for the next few months. In this scenario, we continue to advice our moderately aggressive and aggressive investors to take an exposure into dynamic bond funds with a time horizon of 2 years.

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