Reserve Bank of India’s First Bi-Monthly Monetary Policy Review of Fiscal 2016/17

April 5, 2016

The main policy interest rate, the repo rate, was cut 25 basis points to 6.5%, lowest since 2011, while the reverse repo rate was hiked by 25 bps to 6.0%.  The narrowing of the corridor between the rates was one of several actions intended to strengthen the pass-through of changes in central bank policy rates to bank lending costs.  The statement released by Governor Rajan notes,

Perhaps more important at this juncture is to ensure that current and past policy rate cuts transmit to lending rates. The reduction in small savings rates announced in March 2016, the substantial refinements in the liquidity management framework announced in this policy review and the introduction of the marginal cost of funds based lending rate (MCLR) should improve transmission and magnify the effects of the current policy rate cut. The stance of monetary policy will remain accommodative. The Reserve Bank will continue to watch macroeconomic and financial developments in the months ahead with a view to responding with further policy action as space opens up.

The statement gives a thumbs-up to the recently unveiled government budget:

In the Union Budget for 2016-17, the Government has adhered to the path of fiscal consolidation and this will support the disinflation process going forward. The Government has also set out a comprehensive strategy for reinvigorating demand in the rural economy, enhancing the economy’s social and physical infrastructure, and improving the environment for doing business and deepening institutional reform. The implementation of these measures should improve supply conditions and allow efficiency and productivity gains to accrue. Given weak private investment in the face of low capacity utilization, a reduction in the policy rate by 25 bps will help strengthen activity and aid the Government’s initiatives.

A number of steps were taken to support market liquidity.  The central bank will

i) smooth the supply of durable liquidity over the year using asset purchases and sales as needed;

ii) progressively lower the average ex ante liquidity deficit in the system to a position closer to neutrality;

iii) narrow the policy rate corridor from +/-100 bps to +/- 50 bps, with a view to ensuring finer alignment of the WACR with the repo rate;

iv) ease liquidity management for banks without abandoning liquidity discipline by reducing the minimum daily maintenance of CRR from 95 per cent of the requirement to 90 per cent with effect from the fortnight beginning April 16, 2016;

v) allow substitution of securities in market repo transactions in order to facilitate development of the term money market; and 8 vi) consult with the Government on how to moderate the build-up of cash balances with the Reserve Bank.

All in all, officials are satisfied with the evolution of inflation and growth but feel more was needed to fortify the responsiveness of the banking system to policy changes.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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