RBI HQ in Mumbai
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Raghuram Rajan
RBI Governor

On the basis of an assessment of the current and evolving macroeconomic situation, the Reserve Bank of India has kept its policy rates unchanged in its fifth bimonthly monetary policy announced on December 2. Thus, policy repo rate under LAF remains at 8 per cent, CRR 4 per cent, reveres repo rate 7 per cent, and MSF rate and bank rate at 9 per cent. It would continue to provide liquidity up to 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity up to 0.75 per cent of NDTL for 7-day and 14-day term periods through auctions, and continue with daily one-day term repos and reverse repos to smooth liquidity.

A change in the monetary policy stance at the current juncture is premature, says the apex bank, but comforts, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year.

Policy stance and rationale
Retail inflation has been on the decline, which reflects, to some extent, transitory factors such as favourable base effects and the usual softening of fruit and vegetable prices that occurs at this time of the year. On the other hand, protein-rich items such as milk and pulses continue to experience upside pressures. The absence of adequately administered price revisions in inputs like electricity has contributed to the easing of price rise in the fuel group, even as non-food, non-fuel inflation is still above headline inflation.

Administered price corrections, as and when they are effected, weaker-than-anticipated agricultural production, and a possible rise in energy prices on the back of geopolitical risks could alter the currently benign inflation outlook significantly.

The main near-term uncertainty is the durability of a likely post-November upturn in prices. Thus, there could be some firming up of cereals, oilseeds and pulses prices in view of northeast monsoon’s deficient performance so far and the expected shortfall in Kharif production. As for medium-term outlook, the risks to the January 2016 target of 6 per cent appear evenly balanced under the current policy stance. RBI has revised downward its forecast for CPI inflation to 6 per cent for March 2015.

Assessment of recent trends
While activity appears to have lost some momentum in Q2, probably extending into Q3, conditions congenial for a turnaround – the softening of inflation; easing of commodity prices and input costs; comfortable liquidity conditions; and rising business confidence as well as purchasing activity – are gathering. These conditions could enable a pick-up in Q4.

The rise in investment, which is critical for a sustained pick-up in overall economic activity, is still not in sight. Slow pace of reviving stalled projects, despite government efforts, warrants policy priority, even as ongoing efforts to ease stress in the financial system unlock resources for financing the envisaged investment push. A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be the key to reviving growth and offsetting downside risks emanating from agriculture and exports.

The fiscal outlook should brighten because of the fall in crude prices, but weak tax revenue growth and the slow pace of disinvestment suggest some uncertainty about the likely achievement of fiscal targets, and the quality of eventual fiscal adjustment.

The deficiency in the northeast monsoon rainfall has constrained the pace of Rabi sowing, except in the southern states. Despite reasonable levels of water storage in major reservoirs, the Rabi crop is unlikely to compensate for the decline in Kharif production and consequently, agricultural growth in 2014-15 is likely to be marginal.

RBI has retained economy growth forecast at 5.5 per cent for the current fiscal, with a gradual pick-up in momentum through 2015-16 on the assumption of a normal monsoon and no adverse supply/financial shocks.

With deposit mobilisation outpacing credit growth and currency demand remaining subdued — in relation to past trends, banks are flush with funds, leading a number of banks to reduce deposit rates, though because of various reasons lending rates have not yet come down.

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