RBI monetary policy takeaways: What the central bank thinks of growth, NPAs, liquidity
Given that banks have closed their accounts in March, the market was keen to get a clear number on the demonetisation exercise in terms of the return of old notes to the system.
The credit policy was not expected to be a major event as the repo rate was not expected to be changed. But the Reserve Bank of India (RBI) policy statement does contain some very interesting insights which should be considered when forming a view on the economy and financial sector.
First, the RBI is sanguine about growth in FY18 and has projected Gross Value Added (GVA) growth to be 7.4 percent as against 6.7 percent last year. While this sounds good, it still does not reflect a major recovery as Gross Domestic Product (GDP) growth in FY16 was 7.9 percent (with GVA growth of 7.8 percent). Therefore, it will still take some time before we move past the 8 percent mark. An inference can be that the economy will regain some lost ground, though not move into a high growth trajectory which will be contingent on the monsoon, private consumption and investment.
Second, inflation has been projected to be between 4.5-5 percent for the year with some caution being posted on the monsoon progress. The future course of monetary policy action is contingent on Consumer Price Index (CPI) inflation and given the domination of food items in the index, this factor is important. The RBI has hence has indicated indirectly that not much action can be expected on interest rates front until a clear picture emerges here which will be in August-September. Hence possibilities of further rate cuts may be considered only in the second half of the year.
Third, the RBI has lowered the corridor around the repo rate. Hence, while the repo rate is unchanged, the reverse repo rate is up to 6 percent and the Marginal Standing Facility (MSF--the amount one can borrow from the RBI beyond the repo under specified conditions) is 6.5 percent. This is part of the recommendations made earlier and hence is not new. But the timing is useful for banks which have surplus liquidity and have to deploy their funds with the RBI as they are paying deposit holders interest. A higher rate of 6 percent helps them to a large extent given that surplus liquidity in the system is around Rs 4.8 lakh crore.
A shorter corridor around the repo rate is good for the call market where volatility gets lowered as rates move in a shorter range. It may be recollected that this corridor had been as high as 150 bps at one time and has been lowered gradually. This can be considered to be a positive for the market.
Fourth, the RBI has not quite said anything specific about Non-performing assets (NPAs) but will be coming out with another paper on prompt corrective action which addresses some of the issues. However, this will be more in the area of identification and taking preventive action and not related to disposal of existing stock of bad debt. Higher capital norms have been specified for Asset Reconstruction Companies, which is pragmatic though it is uncertain as to how this will result in more of such institutions given the other issues relating to sale of bad loans by banks.
Fifth, the RBI has put forward a proposal to set up a standing deposit facility to the government whereby banks can park their surplus funds with the RBI without bonds as securities. This move may seem pertinent at a time when there are fewer surplus securities with the RBI which can be used for the reverse repo auctions. Having access to such a window will address the issue of having securities to back up such transactions. This may not be used too often as such situations do not occur frequently. Presently, it may be expected that a large part of this surplus will get absorbed by government borrowing which has been pitched at a higher level for the first half of the year.
Some indicators that are missing from the statement relate to the banking sector: Given that banks have closed their accounts in March, the market was keen to get a clear number on the demonetisation exercise in terms of the return of old notes to the system. Second, the RBI has not provided any direction on the future growth in bank deposits and credit which was also an integral part of the first policy in the past. It does appear that the situation is still nebulous as bank credit growth has been extremely sluggish in the last two to three years. Third, the contours of money supply growth have also not been addressed in this policy.
Fourth, the market was expecting some guidance on the RBI stance on the rupee even though the RBI has reiterated in the past that it does not target any number and is only interested in orderly operations in the market.
Hence the major takeaways are that the RBI expects the economy to do better, but will calibrate interest rate action to inflation trends that are linked with the monsoon. Addressing liquidity is a short term goal which will be through conventional tools of reverse repo or OMOs. NPAs is an issue but would be handled separately.
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