The Reserve Bank of India (RBI) today, on the basis of its assessment of the current and evolving macroeconomic situation, decided to keep its key policy repo rate under the liquidity adjustment facility (LAF) unchanged at 8 per cent and the cash reserve ratio (CRR) of scheduled banks at 4 per cent of net demand and time liability (NDTL).
In its first bi-monthly Monetary Policy Statement 2014-15 here, RBI Governor Raghuram Rajan said the central bank had also decided to increase the liquidity provided under 7-day and 14-day term repos from 0.5 per cent of NDTL of the banking system to 0.75 per cent, and decrease the liquidity provided under overnight repos under the LAF from 0.5 per cent of bank-wise NDTL to 0.25 per cent with immediate effect.
Consequently, the reverse repo rate under the LAF will remain unchanged at 7 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 9 per cent.
The statement said that, since the Third Quarter Review of January 2014, global activity appears to have moderated on slower growth in the United States, the United Kingdom and Japan, continuing sluggishness in the Euro area and a subdued pick-up in emerging and developing economies, restrained by the uncertain external demand environment as well as by localised cyclical and structural constraints.
For a number of emerging markets, further tightening of external financing conditions and renewed volatility of capital flows are the biggest risks to their outlook, it said.
"Going forward, global growth is likely to strengthen in the rest of the year, with risks tilted to the downside," it said.
According to it, domestically, real GDP growth continued to be modest in Q3 of 2013-14, with some strengthening of activity in services such as trade, hotels, transport and communication, and financing, real estate and business services. Despite some positive movement in more recent data, industrial activity continues to be a drag on the economy, with retrenchment in both consumption and investment demand reflected in the contraction of output of consumer durables as well as capital goods.
"In the quarters ahead, the boost provided by robust agricultural production in 2013 may wane. Moreover, the outlook for the 2014 south-west monsoon appears uncertain. Sluggishness in industrial activity, exports and several categories of services underlines the need to revitalise productivity and competitiveness," it said.
Dr Rajan said retail inflation measured by the consumer price index (CPI) moderated for the third month in succession in February 2014, driven lower by the sharp disinflation in food prices, although prices of fruits, milk and products have started to firm up.
Excluding food and fuel, however, retail inflation remained sticky at around 8 per cent. This suggests that some demand pressures are still at play, he said.
The statement said the merchandise trade deficit was 22 per cent lower in April-February 2013-14 than its level a year ago, due to the large decline in non-oil imports. The steady narrowing of the trade deficit over the year has shrunk the current account deficit (CAD) to 0.9 per cent of GDP in Q3 of 2013-14.
It said that, for the year as a whole, the CAD is expected to be about 2.0 per cent of GDP. Most recently, however, export growth has slowed, partly because of slowdown in demand in partner countries as well as a softening of prices of exports of petroleum products and gems and jewellery (offset by a reduction in the prices of oil and gold imports).
Whether the export slowdown persists as global growth picks up once again remains to be seen, it said.
"In February, there was a turnaround in portfolio flows as investors largely priced in the effects of taper by the US Fed and responded to economic and geo-political developments in emerging markets with re-allocations. With sustained inflows in the form of portfolio flows, foreign direct investment (FDI) and external commercial borrowings, external financing conditions turned comfortable. Inflows, augmented by repayments by public sector oil marketing companies of their foreign currency obligations to the Reserve Bank during March, have led to an increase in reserves," it said.
Turning to liquidity, envisaging pressures from large currency demand and tax
outflows from mid-March, a 21-day term repo of Rs 500 billion was conducted on March 14 and 7-day term repo auctions of Rs 100 billion on March 19 and 26, in addition to the regular 14-day term repo of `400 billion on March 21. A 5-day term repo for a notified amount of Rs 200 billion was conducted on March 28 to facilitate non-disruptive banking operations during the annual closing of accounts. Access to the MSF on March 29 and 31 (holidays) was also allowed for this purpose. The Reserve Bank will continue to monitor the liquidity conditions and actively manage liquidity to ensure adequate flow of credit to the productive sectors, it said.
The statement said that, since December 2013, the sharper than expected disinflation in vegetable prices has enabled a sizable fall in headline inflation.
"Looking ahead, vegetable prices have entered their seasonal trough and further softening is unlikely. Meanwhile, CPI inflation excluding food and fuel has remained flat. There are risks to the central forecast of 8 per cent CPI inflation by January 2015 stemming from a less-than-normal monsoon due to possible el nino effects; uncertainty on the setting of minimum support prices for agricultural commodities and the setting of other administered prices, especially of fuel, fertiliser and electricity; the outlook for fiscal policy; geo-political developments and their impact on international commodity prices," it said.
"There will also be a downward statistical pull on CPI inflation exerted by base effects of high inflation during June-November 2013. It is critical to look through any transient effects, including these base effects, which could temporarily soften headline inflation during 2014," it said.
The statement said that the RBI's policy stance would be firmly focussed on keeping the economy on a disinflationary glide path that is intended to hit 8 per cent CPI inflation by January 2015 and 6 per cent by January 2016.
"At the current juncture, it is appropriate to hold the policy rate, while allowing the rate increases undertaken during September 2013-January 2014 to work their way through the economy. Furthermore, if inflation continues along the intended glide path, further policy tightening in the near term is not anticipated at this juncture," it said.
"Contingent upon the desired inflation outcome, real GDP growth is projected to pick up from a little below 5 per cent in 2013-14 to a range of 5 to 6 per cent in 2014-15 albeit with downside risks to the central estimate of 5.5 per cent," it said.
Lead indicators do not point to any sustained revival in industry and services as yet, and the outlook for the agricultural sector is contingent upon the timely arrival and spread of the monsoon. Easing of domestic supply bottlenecks and progress on the implementation of stalled projects already cleared should brighten up the growth outlook, as would stronger anticipated export growth as the world economy picks up.
In pursuance of the Dr. Urjit R. Patel Committee's recommendation to de-emphasise overnight "guaranteed-access" windows for liquidity management and progressively conduct liquidity management through term repos, the Reserve Bank has decided to further reduce access to overnight repos under the LAF while compensating fully with a commensurate expansion of the market’s access to term repos from the Reserve Bank.
"The primary objective is to improve the transmission of policy impulses across the interest rate spectrum. The term repo has evolved as a useful indicator of underlying liquidity conditions. It also allows market participants to hold liquidity for a longer period, thereby providing the impetus for engaging in term transactions in the market, evolving market-based benchmarks for pricing various financial products and also improving efficiency in cash/ treasury management," it said.
The statmement said liquidity conditions have tightened in March, partly on account of year-end ‘window dressing’ by banks, though an extraordinary infusion of liquidity by the Reserve Bank has mitigated the tightness. The Reserve Bank will propose measures to reduce such practices, it added.