RBI stands pat even as policy transmission stays sluggish

Monetary policy review by CRISIL Research

The Reserve Bank of India (RBI) kept its policy rate unchanged at 7.75% during its monetary policy review meeting on Tuesday, February 3, nearly three weeks after surprising the Street with a 25 basis points (bps) cut on January 15. Policy action at its next meeting in April will be determined by how consumer price inflation for January and February prints, and developments in the Union budget for the next fiscal. We expect the RBI to cut rates by 50-75 basis points through next fiscal. However, transmission of lower policy rates to lower lending rates and eventually growth will be a slow process given high non-performing assets (NPAs) at banks and downward rigidity in lending rates.

On January 15, the RBI had said further easing would hinge on data confirming disinflationary trend and sustainability of high-quality fiscal consolidation. Since there were no new developments on this score, rates stayed on hold.

We now expect the RBI to cut rates by 50-75 basis points through the next fiscal. How quickly they come about will depend on the quality of fiscal consolidation and measures to improve the economy’s potential so that higher GDP growth does not set off fresh price fires. We expect inflation, which has fallen below the RBI’s expected trajectory in recent months, to average 5.8% in 2015-16.

On Tuesday, the RBI reduced the statutory liquidity ratio (SLR) by 50 bps to 21.5% of net demand and time liabilities (NDTL). This improves the elbow room for banks to expand credit and boost growth.

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The RBI also replaced the export credit refinance (ECR) facility with the provision of system-level liquidity. Given low recourse to ECR because of comfortable liquidity in the banking system, and in an attempt to do away with sector-specific refinancing, the RBI has merged ECR with system-level liquidity provision. Cash reserve ratio (CRR) was unchanged at 4% of NDTL.

The RBI also revised its GDP growth forecast for 2015-16 upwards to 6.5%. It also said the new GDP series (with 2011-12 as the base year) and advance estimate for 2014-15 could result in yet another revision of its growth projection for next fiscal. We will revisit our GDP growth outlook (at 5.5% and 6.3% for 2014-15 and 2015-16, respectively) once the Central Statistical Organisation releases third-quarter estimates for 2014-15 on February 9.

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