Monsoon awaited for upward pressures

The second bi-monthly monetary policy statement of RBI Governor Dr. Raghuram Rajan, on June 7 leaves policy rates unchanged, as was expected, given the recent upsurge in CPI inflation with its future trajectory "somewhat uncertain".

He, however, looks to a strong monsoon to exert beneficial impact on both prices and consumption during 2016/17. "A strong monsoon, continued astute food management, as well as steady expansion in supply capacity, especially in services, could help offset the upward pressures.

Given the uncertainties, the Reserve Bank will stay on hold, but the stance of monetary policy remains accommodative" Dr. Rajan said  The central bank would watch macroeconomic and financial developments in the months ahead with a view to responding as space opens up.

Dr. Rajan's statement has also retained CPI inflation at "around 5 percent" as well as the GVA (Gross Value Added) projection of 7.6 percent, for fiscal 2017, as in the April review. 

The latest policy statement keeps the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.5 percent and the cash reserve ratio (CRR) of scheduled banks also unchanged at 4.0 percent of net demand and time liabilities (NDTL).

Liquidity would continue to be provided as required but the average ex-ante liquidity deficit in the system would be lowered from one percent of NDTL to a position closer to neutrality. Consequently, the reverse repo rate under the LAF will remain unchanged at 6.0 percent, and the marginal standing facility (MSF) rate and the Bank Rate at 7.0 percent.

There were no market expectations of a further easing of policy rates in this second bi-monthly monetary policy statement in view of the known spike in CPI since April and a reversal in commodity prices, which was also reflected in the wholesale price index.

On the other hand, greater interest turned for financial markets all over on the issue of continuance of the internationally-acclaimed Governor Raghuram Rajan beyond September when his three-year tenure ends. This would not have arisen at this stage but for vitriolic attacks on his stewardship from a ruling party (BJP) nominee, Subramanian Swamy.

There has been  surprisingly no reaction  to such attacks from the Government leaders, including Prime Minister Narendra Modi, even though reports had earlier spoken of  a rapport between the two. 

Among Central bank governors, Dr Rajan holds a unique voice and is also at the forefront in demanding a more balanced global monetary system, with greater involvement in emerging economies. Whatever Dr Rajan's own preference, the Modi Government, fully engaged in cultivating global investors, would certainly seek to avoid adverse consequences in the manner of its dealing with a  personality of international stature.

In the second bi-monthly review, Dr Rajan referred to the forecast of an above-normal and well-distributed south-west monsoon  and said realisation of this prediction is critical for the outlook for agriculture especially with the very low levels of reservoirs in the country. 

While manufacturing remains subdued, RBI's forward-looking surveys indicate an improvement in the overall business situation, driven by a pick-up in capacity utilisation and in order books.  These developments have improved the expectation of business conditions in the first half of 2016-17.

Public investment, especially in roads and railways, is gaining strength, though the continuing weakness in private investment is of concern. Demand conditions are likely to improve going forward and rural demand would get aided by a stronger monsoon. Rising capacity utilisation should prompt private investment.

On price situation, RBI noted, taking food and other consumer prices and elevated levels of Services inflation including transport and other charges into account, inflation was sticky and above 5 percent. However, since growth in rural wages and corporate staff costs have been modest, cost-push factors may be subdued for the time being.

But, there are upside risks – firming international commodity prices, especially crude oil; the implementation of the 7th  Pay Commission awards which will have to be factored into projections, the upturn in inflation expectations of households and of corporates; and the stickiness in inflation excluding food and fuel.

Thus, the statement maintains  the  earlier inflation projection of around 5 per cent, though with an upside bias. Clarification should come from incoming data in the next few months Dr. Rajan said.
On growth, RBI says domestic conditions are improving gradually, mainly driven by consumption demand,  expected to strengthen with a normal monsoon and the implementation of the Seventh Pay Commission award. 

Higher public sector capital expenditure, led by roads and railways, should crowd in private investment. However, unrelenting global factors may restrain business confidence.Dr Rajan acknowledges that more monetary transmission to support the revival of growth continues to be critical. 

The government’s reform measures on small savings rates combined with the Reserve Bank’s refinements in the liquidity management framework should help the transmission of past policy rate reductions into lending rates of banks, he said.

The Reserve Bank will shortly review the implementation of the Marginal Cost Lending Rate framework by banks. Timely capital infusions into constrained public sector banks will also aid credit flow, Dr Rajan said. As it is, he is due to present the third bi-monthly policy statement on August 9.  

(The views expressed are strictly personal.)
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