RBI slashes policy repo rate by 50 bps to 6.75%

The Reserve Bank of India (RBI) today announced a 50-basis point reduction in its key repo rate from 7.25 per cent to 6.75 per cent, bringing it to the lowest level since May 2011.

Repo (or repurchase) rate is the rate at which the central bank buys back government bonds from banks, in order to pump liquidity into the banking system.

With this, the reverse repo rate under the liquidity adjustment facility (LAF) also stands adjusted to 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 7.75 per cent, respectively, RBI stated.

In the fourth bi-monthly monetary policy statement for 2015-16, RBI kept the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liability (NDTL).

The central bank said it would continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 14-day term repos as well as longer term repos of up to 0.75 per cent of NDTL of the banking system through auctions.

RBI said it would continue with daily variable rate repos and reverse repos to smooth liquidity.

RBI said the rate reduction has been prompted by a moderation in growth, which was evident across most emerging economies since the third bi-monthly monetary policy review of August 2015.

A broad-based disinflation and a decline in non-food and non-fuel inflation rates also aided the policy stance RBI said.

Moreover, RBI noted that markets have passed on the benefits of the US Federal Reserve's decision to postpone a hike in key lending rate as part of its policy normalisation.

Global trade has deteriorated further and downside risks to growth have increased.

In the United States, industrial production slowed as capital spending in the energy sector was cut back and exports contracted, weighed down by the strength of the US dollar.

Governor Raghuram Rajan also announced a downward revision, the second this year, in the Reserve Bank's growth projection for the year - to 7.4 per cent from the earlier 7.6 per cent (See: RBI lowers FY16 GDP growth forecast to 7.4%).

RBI said while a tentative economic recovery is underway, it is still far from robust. In agriculture, sown area has expanded modestly from a year ago, reflecting the timely and robust onset of the monsoon in June, and despite a 14 per cent deficiency in the southwest monsoon and a 20 per cent deficiency in production-weighted rainfall, the first advance estimates indicate that food grain production is expected to be higher than last year.

Rural demand, however, remains subdued as reflected in still shrinking tractor and two-wheeler sales, RBI said.
 
Manufacturing growth has been uneven in April-July, with industrial activity slowing sequentially in July, although it has been in expansionary mode for the ninth month in succession. Industries such as apparel, furniture and motor vehicles have experienced acceleration.

Furthermore, the resumption of growth in production of consumer durables in recent months, after a protracted period of contraction over the last two years, is indicative of some pick-up in consumption demand, primarily in urban areas, RBI noted.

However, RBI says, external demand conditions have turned weaker since its last policy review, suggesting a more persistent drag from lower exports and cheaper imports due to global overcapacity.

This contributes to continuing domestic capacity underutilisation, decelerating new orders and a rising ratio of finished goods inventories to sales.

As a result of still tepid aggregate demand, output price growth is weak, but input material costs have fallen further, leading to an increase in margins for most producers.

Weak aggregate demand appears to have more than offset the effect of higher margins to hold back new investment intentions.

The expansion in capital goods production, therefore, likely relates more to the revival of stalled projects than to a build-up of the green field pipeline.

In the service sector, construction activity has weakened which is being reflected in low demand for cement and the large inventory of unsold residential houses in some localities.

Rising public expenditure on roads, ports and eventually railways could, however, provide some boost to construction going forward.

Headline consumer price index (CPI) inflation reached its lowest level in August since November 2014. The ebbing of inflation in the year so far is due to a combination of low month-on-month increases in prices and favourable base effects.
 
Overall year-on-year food inflation dropped sharply, led by vegetables and sugar.

Cereal inflation moderated steadily during April-August, but price pressures in respect of pulses and onions remained elevated.

Liquidity conditions also eased considerably during August to mid-September. In addition to structural factors such as deposit mobilisation in excess of credit flow, lower currency demand and pick-up in spending by the government contributed to the surplus liquidity, RBI noted.

With the weakening of growth prospects in most emerging market economies and world trade volume growth falling below world GDP growth, India's merchandise exports continued to decline in the first two months of Q2.

RBI expects the widening of the merchandise trade deficit to lead to a modest increase in the current account deficit (CAD) during Q2.

Net capital inflows were buoyed by sustained foreign direct investment and accretion to non-resident deposits, and reduced by portfolio outflows, mainly from equity markets. Foreign exchange reserves rose by $10.4 billion during the first half of 2015-16.

RBI noted that although a tentative economic recovery is underway, it is still far from robust. However, it noted that since the last policy review, the bulk of the conditions for further accommodation, including inflation levels, have been met.

While inflation is expected to go up in the coming months, RBI expects to achieve the 6 per cent inflation target by January 2016 and strive to reach the 5 per cent level by the end of fiscal 2016-17.