India: Reserve Bank keep rates on hold
Published 11 August 2014
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0.1 This publication was archived on 5 August 2016.
This article is no longer current. Please refer to Overseas Business Risk - India
0.2 Detail
Inflation
Consumer Price inflation (CPI) was 7.3% in June, down from levels around 10% in 2013. The RBI in January this year set a target to bring down inflation to 8% by January 2015 and 6% by January 2016. The monetary policy statement notes that while inflation at around 8% in early 2015 seems likely, the balance of risks around the medium-term inflation path, particularly the target of 6% by January 2016, are still to the upside. Upside risks stem from the pass-through of administered price increases, uncertainty over monsoons and their impact on food production, higher oil prices and exchange rate movements, and stronger growth coming up against supply-side constraints.
Growth
The RBI has maintained its 5-6% growth target, with a central estimate of 5.5% , citing a modest improvement in growth prospects. The improvement in growth prospects is attributed to a recovery in exports, a recent pick-up in industrial activity, and expectations of a conducive investment environment along with ongoing fiscal consolidation.
Statutory Liquidity Ratio
The 0.5% reduction in the SLR, to 22% , was the second consecutive reduction in a row, with an earlier 0.5% reduction announced in the June policy statement. The RBI statement notes that the government’s commitment to fiscal consolidation in the recent budget has allowed room for a reduction in the SLR giving space for banks to expand credit to the productive sectors as growth picks up. The RBI’s mandated SLR requirement typically provides a captive market for government debt while restricting credit flow to the private sector.
Reactions
Most market economists are now expecting a prolonged pause in the RBI’s rate cycle. Many had interpreted the RBI’s June policy statement to be dovish, leading them to expect early rate cuts. However, Governor Rajan has indicated that he remains committed to reining in inflation, before initiating rate cuts. Investment Bank Nomura said in a note “Cutting rates too early may be tantamount to a policy flip-flop, a mistake the RBI is likely to want to avoid.”
0.3 Comment
Although the RBI does not have an official inflation targeting mandate, the RBI is staying true to its self imposed discipline. The long term commitment to a reduction in inflation bodes well for the economy and markets.
The RBI has recently introduced guidelines for the Basel III Liquidity Coverage Ratio (LCR) standard which will come into effect from 2015. The LCR aims to ensure that a bank maintains an adequate level of high quality liquid assets that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon. A large part of the LCR requirements will be met by investments in government securities, and current RBI regulations stipulate that LCR requirements be maintained over and above SLR requirements. The RBI’s objective in the calibrated reduction in SLR is also to facilitate banks’ preparedness for the Basel III LCR framework, by reducing the dual burden.
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