In our Budget note, we discussed the fiscal prudence that the Government has decided to maintain, despite the increase in the plan expenditure and the provisions made for the Seventh Pay Commission. This should give confidence to the Reserve Bank of India (RBI) to continue with its monetary easing stance. In line with consensus estimates, RBI cut the policy rate by 25 basis points in the First Bi-monthly Monetary Policy Statement 2016-17 held today. As such the repo rate stands at 6.5 per cent as against 6.75%. The Governor also reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 95% of the requirement to 90% with effect from the fortnight beginning April 16, 2016. The Cash Reserve Ratio (CRR) remained unchanged at 4% of the net demand and time liabilities (NDTL). RBI also narrowed the policy rate corridor from +/-100 basis points to +/-50 basis points by reducing the MSF rate by 75 basis points and increased the reverse repo rate by 25 basis points.
Team RBI was confident that the CPI Inflation will be in a decelerating mode and is expecting it to be at 5% during 2016-17. However, the uncertainties that can disrupt this trend are the recent unseasonal rains, the likely spatial and temporal distribution of monsoon, the low reservoir levels by historical averages, the strength of the recent upturn in commodity prices, especially oil, the persistence of inflation in certain services and the implementation of the Seventh Central Pay Commission.
The Central Bank has also laid down the positives which can impact the inflation trends favorably and the statement is on these lines.
“On the other hand, there will be some offsetting downside pressures stemming from tepid demand in the global economy, Government’s effective supply side measures keeping a check on food prices, and the Central Government’s commendable commitment to fiscal consolidation.”
As far as growth is concerned, RBI retained the projection of 7.6% for 2016-17.
According to the policy statement, “The uneven recovery in growth in 2015-16 is likely to strengthen gradually into 2016-17, assuming a normal monsoon, the likely boost to consumption demand from the implementation of the 7th Pay Commission recommendations and OROP, and continuing monetary policy accommodation. On the other hand, the fading impact of lower input costs on value addition in manufacturing, persisting corporate sector stress and risk aversion in the banking system, and the weaker global growth and trade outlook could impart a downside to growth outcomes going forward”.
The RBI Governor gave positive statements on the measures taken in the Union Budget and his views were on these lines.
“In the Union Budget for 2016-17, the Government has adhered to the path of fiscal consolidation and this will support the disinflation process going forward. The Government has also set out a comprehensive strategy for reinvigorating demand in the rural economy, enhancing the economy’s social and physical infrastructure, and improving the environment for doing business and deepening institutional reform. The implementation of these measures should improve supply conditions and allow efficiency and productivity gains to accrue”.
Dr.Rajan seems to be very serious about the transmission of the policy rates to the lending rates. He was of the view that the Government’s decision to reduce the small savings rates, the substantial refinements in the liquidity management announced in today’s policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission.
The RBI Governor has responded positively to the measures taken by the Government in the Budget and outside by cutting the policy rate in today’s review. However, although the Governor sounded to be accommodative in his policy stance, the uncertainties that he has laid down for inflation and growth is a clear indication that he would go into a further wait and watch mode before the next rate cut. It is also very clear that the Government will fully supplement the RBI’s efforts to make sure that there is a transmission of rate cuts in such a way that the banks cut the lending rates that is very essential to propel economic growth. However, it would be interesting to see how these measures will increase the credit growth in the coming months considering the huge NPAs in the banking sector.
As far as our fixed income investors are concerned, we continue to recommend dynamic bond funds to those whose risk profile is moderately aggressive/ aggressive. On the other hand, our conservative and moderately conservative investors, who do not wish to face volatility caused by the monetary stance of the RBI can take an exposure into short term funds.