In the fourth bi-monthly monetary policy review, the Reserve Bank of India (RBI) came out with a masterstroke.
The piéce de résistance was the 50 bps cut in the benchmark repo rate, which in a pleasant surprise, was higher than the 25 bps rate action widely expected by the markets. Cumulatively, the central bank has now lowered its policy rate by 125 bps since the start of 2015. Besides interest rates, the RBI concomitantly continues to focus on market reforms to further its objective of fine-tuning the financial architecture with evolving needs of the economy.
The successful curtailment of inflation over the last two years has been the most important macro accomplishment for the Indian economy. In fact, over January-August 2015, average WPI and CPI inflation fell by 800 bps and 304 bps respectively. While weak demand conditions and soft commodity prices played an enabling role, government’s astute management of the food economy has clearly made the difference despite the unsupportive monsoon backdrop for two straight years.
Going forward, the ongoing tectonic shifts in the global economy will keep disinflationary pressures intact via the channel of excess capacity in certain sectors and a subdued commodity price environment. This in my opinion will provide unbridled support to RBI in navigating from the 6 per cent inflation target for January 2016 to 5 per cent for March 2017.
The half-yearly policy review comes on the heels of RBI making incremental progress in the area of financial market liberalisation.
— With the objective of improving affordability of low cost housing, the central bank has proposed a reduction in current risk weight of 50 per cent applicable on individual housing loans.
— After granting in-principle licence for niche banking earlier, the RBI has now allowed incremental Rs.1,700 billion investment in government debt securities by foreign portfolio investors.
— Indian corporates will now be permitted to issue Rupee denominated bonds in overseas centres. This will help corporates tap additional source of funding without exposing themselves to currency risk.
The Indian economy has started to make structural macro adjustments and now rightfully offers a bright spot in the cloudy global environment. Policy steps in the area of ease of doing business, manufacturing, skill development, digitisation, inclusion, development of institutional architecture, cooperative federalism, etc. will no doubt augment India’s potential economic growth to above 9 per cent in years to come.
In this environment, risks to medium-to-long term inflation would be on the downside as the government steps up supply side reforms, creates capacity in infrastructure, and remains committed to quality fiscal consolidation. Hence, I foresee an opportunity for incremental 75 bps of monetary easing during the second half of 2015-16.
In addition, on the regulatory front, to further improve the systemic provisioning coverage on NPAs and Restructured Assets, RBI could consider allowing banks to dip into their Standard Asset Provisions/Reserves by 15 to 25 bps from the extant maintenance of 40 bps, as a one-time measure, as risks in the system has largely been recognized through NPAs and Restructured Assets
