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Reserve Bank focusing on stable economic upswing
Highlights
In its fifth bi-monthly monetary policy review, Reserve Bank of India (RBI) kept the benchmark rates intact as per market expectations. But clearly, it has provided broad positive forward outlook view on further softening of interest rates as and when the macroeconomic fundamentals support such action. Since the economy is in the early stages of recovery despite some areas of continued weakness, RBI is very emphatic in bringing more stability and sustainability to the revival of growth of the economy.
In its fifth bi-monthly monetary policy review, Reserve Bank of India (RBI) kept the benchmark rates intact as per market expectations. But clearly, it has provided broad positive forward outlook view on further softening of interest rates as and when the macroeconomic fundamentals support such action. Since the economy is in the early stages of recovery despite some areas of continued weakness, RBI is very emphatic in bringing more stability and sustainability to the revival of growth of the economy. Retail inflation measured by the consumer price index (CPI) increased for the third successive month in October 2015, pushed up by a surge in the monthly momentum. Food inflation rose sharply, driven especially by pulses. Keeping in view the inflation target of 6 per cent for Jan 2016 and 5 per cent by March 2017, a deft management of liquidity by RBI and its interdependent factors will be needed. With US dollar getting close to Rs 67, it needs greater monitoring to combat volatility. More important is the astute supply side management of essential commodities by the central government, including close coordination with State governments, to keep the inflation under check. With international crude oil prices touching a low of US $ 37.34 per barrel on December 8, fiscal deficit can be reined in.
Positive economic outlook
The overall outlook for agriculture is moderate, IIP began to pick up from Q2 of FY16 onwards, manufacturing sector is growing at 9.3 per cent and new project announcements as measured by the Centre for Monitoring Indian Economy (CMIE) grew more strongly in the second quarter. The investment to GDP ratio has slightly moved up from 29.8 per cent in Q1 to 30.1 per cent in FY16, providing some impetus to investment sentiments. Some other positive dimensions of the economy include, decline in bullion imports despite the festival season that helped narrow the trade deficit in October as well as over the financial year so far, moderating the current account deficit further. Net foreign direct investment (FDI), external commercial borrowings (ECB) and accretions to non-resident deposits have risen in relation to last year; however, portfolio outflows from both debt and equity segments rose in November. During 2015-16 (up to November 20), there has been an accretion of US$ 10.8 billion to the foreign exchange reserves. In the back drop of Q2 GDP rising at 7.4 per cent, India is well poised to grow at RBI’s projected rate of 7.4 per cent during the current fiscal with continuing downside risk.
Challenges for Banks
Among many, banks will have major challenges to (a) further fine-tuning the base rate – so far only half of 125 basis points of repo rate cut of RBI have been transmitted by banks. Having already significantly cut the deposit rates, RBI expects that bank should be in a better position to reduce their base rate further to pass on the rate cut. (b) Implement revised basis of calculation of base rate on using marginal funding cost from April 2016. (c) Cleaning up bank’s balance sheets by 2017 by controlling Non Performing Assets (NPAs). The empowerment of banks through Strategic Debt Restructuring (SDR) and 5/25 lending scheme tailored for infrastructure sector need to be fully utilized for the purpose. (d) Accelerating credit growth to help revive the economy. (e) Reduce further deterioration of asset quality by streamlining internal credit appraisal systems.
Global headwinds
With growing certainty of interest rate hike by US Federal Reserve in the middle of December 2015 for the first time after June 2006, the flight of overseas funds from emerging markets to rest of the world seems imminent. The IMF’s move to admit Chinese currency into the elite class of world reserve currencies could lead to a spell of turbulence and a short term weakening of the dollar. In view of the move of the Federal Reserve, global markets may respond unpredictably sending its jitters to Asian markets. RBI is making all efforts to mitigate such global risks better aligning its domestic currency and interest rate management policy. Once the initial impact is absorbed by the domestic markets, further policy measures can be initiated.
Thus, maintaining status quo in interest rates has been a move aimed at bringing sustainability to the growth momentum in the view of evolving external environment, particularly the US Fed action; looming price escalation of certain sensitive commodities and risk of rising inflation and likely surge in demand for credit during busy period Q3 and Q4 of FY16. Lot of action is expected from banks to put the economy on a faster revival mode. Rest of the ecosystem seems firmly in place. On the whole, RBI is candid in its focus on sustainability of revival of growth of the economy assuring markets that further rate cut can happen if macroeconomic fundamentals continue to be stable and able to absorb the impact of Fed action.
(The author teaches at the National Institute of Bank Management (NIBM), Pune. The views are his own)
Dr K Srinivasa Rao
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