Review On Macroeconomic And Monetary Developments

Published Date: 02 Nov 2017

The RBI yesterday made the following comments and observations with regard to major macro-parameters, making a case for the pursuance of a cautious monetary policy stance:

1. On Inflation – WPI inflation by March 2013 at 6.0% turned out to be lower than RBI projection of 6.8%. However, with headline (and CPI) inflation remaining above the threshold level for most part of last year, the room for monetary accommodation is limited. Policy re-calibration could be in either direction during FY14

Headline inflation to be range-bound in FY14 – moderation in H1-FY14 due to subdued producers pricing power and falling global commodity prices. Some increase in H2-FY14 as base effect plays in.

2. On growth and recovery – Planned corporate investment moderated sharply last year (bottlenecks in coal, power, telecom and road sectors), aggregate demand remained sluggish with inflation negatively impacting real consumption

Output gap to diminish but remain negative in FY14 - need to eliminate/minimise structural bottlenecks, particularly in infra-space.

3. on global conditions – fiscal adjustments to drag growth in advanced countries and delay cyclical recovery in emerging market and developing economies (EMEs)

Tail risks remain significant – need to reduce balance sheet exposures and prepare buffer against possible contagion risks

4. On CAD – modest pick-up in exports and deceleration in imports in Q4 FY13 likely to help reduce current account deficit (CAD). CAD adequately financed in FY13 by capital inflows, without reserves depletion. External vulnerability has worsened, with increased dependence on ECB and short-term debt.

Risks to CAD persist, with possibility of sudden stop or reversal in capital inflows. Fall in global commodity prices to provide temporary respite.

The primary focus of monetary policy has been the creation of a balance in the growth-inflation dynamics. Growth has decelerated continuously and steeply, more than halving from 9.2% in Q4 FY11 to 4.5% in Q3 FY13. At the same time, inflation has eased a bit coming closer to RBI’s tolerance threshold.

While monetary and liquidity conditions have been managed reasonably through policy rate reduction (100 bps) and injection of primary liquidity through OMOs (Rs 1.5 trillion), SLR reduction (by 100 bps) and CRR reduction (by 75 bps to inject Rs 1.3 trillion), credit-off take has been below the projected trajectory in FY13. This was coupled with deterioration in asset quality; causing banks to turn risk averse.

Further, new risks on the external account have simultaneously emerged during the year gone by and needs due management.

Monetary Measures Announced Today

The RBI in its Annual Credit Policy announcement today –

Reduced repo rate by 25 bps from 7.50% to 7.25%

Consequently, reverse repo now stands at 6.25% and marginal standing facility (MSF) rate at 8.25%

Bank rate now at 8.25%

CRR retained at 4.00% of NDTL

The objective of this monetary policy stance is to address risks to growth and provide required support in this regard whilst simultaneously guarding against re-emerging inflationary pressures and negative impact on inflation expectations. The underlying motive is to manage liquidity to reinforce monetary transmission and ensure adequate credit flows to productive sectors of the economy.

Outlook for FY14

Baseline GDP growth projected at 5.7%

o Industrial activity and new investment flows to remain subdued

o Implementation gaps to persist

o Agri-sector growth to return to trend levels with normal monsoons

o Global growth unlikely to improve significantly, implying sluggish growth in services and exports

WPI inflation to be range-bound around 5.5%

o Imported inflation to be lower, given broadly stable exchange rate

o Food inflation to witness upside pressures due to persisting supply imbalances

o Timing and magnitude of administered prices revisions to influence inflation trajectory

Endeavour to evolve inflation to a level of 5.0% by March 2014 (in the short-term) and 3.0% in the medium-term

Money supply (M3)growth projected at 13.0%

Deposits growth estimate of 14.0%

Non-food credit growth estimate of 15.0%

Implications

The GDP growth estimate comes lower than that projected by the PMEAC (6.4%), Economic Survey (6.1-6.7%) and Budget (around 6.7%). The RBI is more conservative in its projection here. Putting together the inflation projection of 5.5% for the year, nominal GDP is to grow by 11.2% as against the Budget assumption of around 12.8-13%. This could indicate some pressure on the fiscal front if GDP grows at this lower rate as it will impact tax collections.

The lower projection for growth in deposits is significant as this will put pressure on liquidity in the system even though non-food credit is to grow by around 15%. Any fiscal slippage will certainly necessitate RBI action through OMOs and CRR cuts during the year.

Potential Risks

1. CAD has emerged to be the biggest risk, after touching an all-time high last year, being considerably above RBI’s calculation of a sustainable 2.5% CAD. Large fiscal deficits could spill-over to pressure CAD, with further stress on servicing of external liabilities. Global liquidity conditions could alter for EMEs against an uncertain outlook for advanced countries and uncertainty in the QE trajectory. This could negatively impact capital inflows to the country.

2. Sustained revival in growth is constrained by revival in investments, which has been dented by subdued business confidence and dented profitability. Both borrowers and lenders have turned risk averse in the current environment

3. Effectiveness of monetary policy in curbing inflationary pressures could be undermined by supply constraints, upward revisions in MSPs and rapid wage increases creating a wage spiral. Improvements in productivity and competitiveness would be crucial.

What to infer?

The growth-inflation balance continues to remain the focus of monetary policy for the RBI, moving to a growth supporting stance. Lowering interest rates likely acts as a direct stimulus to result in a pick-up in credit and investment flows; however, the full realisation of impact is subject to the effectiveness of monetary transmission.

It may be conjectured that amongst all impending risks, growth concerns need to be addressed first, particularly because the real impact shows only with a lag. Re-emphasis on the need to restore structural efficiency and release pent-up productivity and demand, seeks to draw the attention of the government to reforms initiatives.

As regards the other risks –

ï‚· Liquidity pressures have been adequately tackled from time to time and with improved monetary transmission the credit to deposit ratio could decline

ï‚· CAD is expected to improve temporarily. With gradual revival in global economy trade flows too would improve. Comfort is sought from moderation in global commodity prices and an expectation of a stable exchange rate. With measures such as reduction of withholding tax from 20% to 5%, the government tried to attract and maintain buoyancy in FII inflows, which would help finance CAD during the year.

ï‚· In terms of fiscal deficit, easing of global commodity prices has helped the government cut on its fertiliser and fuel subsidy. Estimated under-recoveries of OMCs have also contracted considerably with decline in global crude prices. This will provide some relief in terms of fiscal consolidation. The same may however be offset by a rising food subsidy bill in the face of continued pressure on prices of primary articles and upward revision of MSPs.

CARE’s expectation

While the developing trajectories of various macro-parameters have come to influence monetary policy considerations, the policy stance of the RBI is primarily governed by growth risks now.

It may be expected that key interest rates would be cut by another 50 bps during the course of FY14 if the inflation rate moves towards the RBI’s target of 5%, with a view to boost business confidence and create a more favourable investment climate. The timing of the rate cut would depend on the prevailing liquidity conditions and inflation dynamics.

Bond yields have not reacted significantly to the policy and the 10 year yield inched up marginally after the announcement of the policy to 7.79%. But with the tendency for rates to only decline in the course of the year, the 10-year yield is likely to be range bound between 7.6-7.9% during the next six months or so. The lowering of HTM SLR securities could pressurize the rates as banks would sell off excess securities though it is difficult presently to ascertain the impact given that this would be spread across four quarters.

Other Regulatory and Supervisions Measures

As customary, the annual policy announces reforms initiatives to make the banking system more robust in the country. Accordingly, the RBI has announced various measures; some key ones have been listed below -

Implementation of Basel III RBI guidelines from April 1, 2013.

o Final guidelines on composition of capital disclosure requirements and on capital requirements for banks’ exposures to central counterparties are to be issued by end-May and end-June 2013 respectively

o Liquidity coverage ratio to be implemented from January 1, 2015

o Net Stable Funding Ratio to be implemented by January 1, 2018

Final guidelines on dynamic provisioning framework to be issued and its implementation in a phased manner by end-June 2013

Prudential guidelines on restructuring of advances by banks/financial institutions to be issued by end-May 2013

Banks allowed to exceed the present limit of 25% of total investments under the Held-to-Maturity (HTM) category provided –

o the excess comprises only of SLR securities

o the total SLR securities held in the HTM category is not more than 23% of their DTL as on the last Friday of the second preceding fortnight (in alignment with current SLR requirement)

reduction to be effected by way of reduction of at least 50 bps every quarter beginning quarter ending June 2013

ï‚· With a view to reducing the demand for gold for domestic use, it has been proposed to restrict import of gold on consignment basis by banks only to meet the genuine needs of exporters of gold jewellery. Guidelines to be issued by end-May 2013

It has been proposed to restrict the facility of advances against security of gold coins per customer to gold coins weighing up to 50 gms. Guidelines to be issued by end-May 2013. Further guideline to govern lending by NSFCs against gold collateral to be issued during the same period.

Proposed to allow FIIs to hedge their currency risks by using exchange traded currency funds in domestic exchanges. Draft Guidelines to be issued by end-July 2013

It has been proposed to increase the risk weight and provisioning requirement on banks’ exposures to corporates on account of the corporates’ un-hedged forex exposure positions to reduce such risks. Guidelines to be issued by end-June 2013

Proposed to carve out a sub-sector of ‘CRE-Residential Housing’ within the Commercial Real Estate (CRE) sector with appropriate prudential regulatory norms on risk weights and provisioning. Detailed guidelines to be issued by end-June 2013

Issue of discussion paper on Banking Structure in India for comments by end-June 2013

CCIL to henceforth, disseminate market liquidity indicators on its website at regular monthly intervals, with a view to enhance transparency and enable better data dissemination in respect of liquidity

Priority Sector Guidelines –

o Increase loan limit for MSEs in services sector to Rs 50 mn per borrower (from Rs 20 mn)

o Increase loan limit for bank loan dealers/sellers of agri-inputs to Rs 50 mn per borrower (from Rs 10 mn)

o Raise limt of pledge loans (including warehouse receipts) to Rs 5 mn (from Rs 2.5 mn) for classification of individual farmers and as indirect agriculture loans in case of corporates, partnership firms and institutions engaged in agri-and allied activities

Financial Inclusion –

o With a view to facilitating Direct Benefit Transfers it is proposed to open bank accounts for open accounts for all eligible individuals in camp mode with the support of local government authorities; seed the existing accounts or the new accounts opened with Aadhaar numbers and put in place an effective mechanism to monitor and review the progress in the implementation of DBT.

o Enhance financial literacy through literacy camps and be innovative in devising suitable communication channels so that the messages reach the target audience effectively