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In the first policy meeting of the monetary policy committee (MPC) chaired by the new Reserve Bank of India (RBI)
governor Urjit Patel, the repo rate was reduced by 25 basis points (bps) to 6.25%. As a result, the reverse repo
adjusted to 5.75% and the marginal standing facility rate (MSF) to 6.75% for maintaining a 100 bps band around the
policy rate. The decision to cut rates was unanimous with all the six members of the MPC voting in favour.
The MPC highlighted that the recent drop in inflation reflects a downward shift in food inflation momentum and opens
up space for policy action. That said, it emphasised that the implementation of the Seventh Pay Commission
recommendations, especially the increase in house rent allowance, and the increase in minimum wages due to
possible spillovers through minimum support prices, could pose a challenge going ahead. Overall, the central bank
has retained its March 2017 inflation target of 5% -- with upside risks that have reduced compared with August.
Since the last monetary policy review meeting, inflation has fallen to 5% in August driven by a sharp drop in food
inflation. This is thanks to a good monsoon year. Rainfall in 2016 has been recorded as normal, at just 3% below the
long-period average. Whats better is that for the first time in 3 years, rains were well-distributed only 33% of the
districts saw deficient rains, compared with 49% in 2015 and 46% in 2014. Moreover, more than half of these deficient
districts are well-irrigated and the many that are not are agriculturally less relevant.
Going ahead, we expect inflation to trend lower and average 4.8% in the second half of fiscal 2017, because of the
good monsoon and supported by steps taken by the government to manage food supply. In our view, the good
monsoon will also push up rural incomes and boost private consumption by 90 bps this fiscal, supporting
GDP growth. Overall, we expect inflation to average 5% and GDP to grow at 7.9% in fiscal 2017.
Our view
For fiscal 2017, we expect CPI to stay soft at 5% on average or 10 basis points (bps) higher than in fiscal
2016 -- given that monsoon has been normal with a favourable temporal and spatial distribution. Good rains will
soften food inflation and offset the upside risk to overall inflation from sticky services inflation. That said, risks to
overall inflation going ahead could emanate from narrowing output gap pushing up core inflation; and, the
Seventh Pay Commission and One Rank One Pension payouts. Further, we expect oil prices to remain contained
at $40-45 per barrel in 2016. That will help keep inflation, fiscal deficit and current account deficit under control.
We expect the favourable monsoon to revive rural incomes. Larger agricultural output will help boost supply
and rural incomes. It will also exert a downward pressure on prices. We estimate that on balance, even with a
fall in food prices, the output effect will weigh in and raise agricultural GDP by Rs 1.49 trillion this fiscal. This is
assuming an above-trend growth of 4% in agricultural output. In fiscal 2016, the increase in agricultural income
was Rs 978 billion. In addition, urban consumption remains healthy and will benefit further from lower inflation,
spillovers from robust agriculture activity in manufacturing and services, greater transmission of past interest rate
cuts, and the Seventh Pay Commission and One Rank One Pension payouts. We believe the upturn in rural
incomes, supported by urban consumption, should push private consumption growth above 8% in fiscal
2017, compared with 7.4% in fiscal 2016.
Loose monetary policies may continue for longer in advanced economies: After Britains decision to exit
the European Union, the Bank of England cut its benchmark interest rates to record lows and upped its bond
buying programme. On the other side, Japan, too, initiated a large fiscal stimulus programme. Further, the outlook
on US Fed action remains uncertain - with expectation that they might raise rates in December. For India, with a
low current-account deficit and improving macroeconomic conditions, these developments mean that it is likely
to attract higher inflows relative to last year.
We expect GDP growth to rise to 7.9% in 2016-17, given a normal monsoon. In comparison, the RBI's growth
forecast for the current fiscal is 7.6% and its inflation target is 5% for March 2017.
In this rate-cutting cycle that began on January 2015, the RBI has brought down the repo rate by 175 bps. While
market-driven interest rates such as those on commercial paper and certificates of deposits fell sharply until
November, they rebounded early this year on tight liquidity conditions. That said, short-term market rates have
fallen 170 bps between January 2015 and September 2016, and G-sec yields 70 bps. Deposit rates have declined
140 bps as the government cut the small savings rate effective April 1, 2016, giving more room to banks to reduce
their deposit rates. This, in turn, will help reduce the cost of funds, which is a key component when pricing loans.
That said, so far, base rates of banks have come down only by about 60 basis points and the marginal cost of
funds based lending rate (MCLR) has come down by 10 bps since April 2016, limiting the boost to consumption
from lower interest rates.
Therefore, the transmission is improving, albeit only gradually. In the coming months, policy transmission is
expected to improve further as the shift to MCLR for pricing loans will also bring down lending rates and
favourable liquidity conditions managed by the RBI will ease any liquidity constraints for banks.
Liquidity has continued to improve with the central bank aiming to maintain it at near-neutral levels. In September,
liquidity remained in excess for the third consecutive month. Accordingly, there was net average daily absorption
through the central banks liquidity adjustment facility or the sum of net repo, net term repo, and marginal
standing facility of Rs 520 billion in September (till 22 September) compared with a net absorption of Rs 320
billion in August.
Going ahead, to manage liquidity, the RBI will have to watch out for spectrum auction and maturity and outflow
of foreign currency non-resident deposits from the banking system.
Figure 1: Policy transmission gradually improving
till Sep 16
Liquidity deficit
2000
1.75
1.7
1500
1.4
1.25
1000
1.1
500
0.7
0.7
0.6 0.6
0.01
0.1
-500
Sep-16
Aug-16
Jul-16
Jun-16
May-16
Apr-16
Mar-16
MCLR**
Feb-16
10 year
Gsec
Jan-16
Base
rate***
Dec-15
Commercial
paper rate**
Nov-15
Deposit
rate***
Oct-15
-1000
Policy Repo
rate*
Source: RBI, CEIC, CRISIL Research, Note: *average, **average across maturities, ***major 10 banks, month-end, MCLR change is since April
2016
12%
10%
Sep-16
Jul-16
May-16
Mar-16
Jan-16
Nov-15
Sep-15
Jul-15
8%
May-15
14%
Mar-15
Jan-15
Nov-14
0%
12%
10%
Sep-16
Jul-16
May-16
Mar-16
Jan-16
Nov-15
Sep-15
Jul-15
8%
May-15
14%
Nov-14
Mar-15
Jan-15
95%
90%
In 2016-17, the CD ratio is expected to range 7880%, as credit offtake is projected to accelerate. In
2015-16, the CD ratio stood at 77.5%.
65%
85%
80%
75%
70%
60%
55%
50%
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
Jul-15
Aug-15
Sep-15
Oct-15
Nov-15
Dec-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Jul-16
Aug-16
Sep-16
Credit-deposit ratio
As of June 2016, PSBs reported 10.6% gross nonperforming asset (GNPA) ratio. Asset quality of
private sector banks was also under pressure, but
their GNPA ratio was healthy at 2.9%.
In 2016-17, GNPAs are forecast to remain elevated,
on account of high slippage, mainly from
restructured standard accounts.
10.50
9.40
10
8
8.5
6
4
2
0
4.40
3.20
2.9
2.10
5.00
7.6
3.60
3.3
1.80
3.8
1.80
4.3
2.10
2.80
3.40
Private Banks
2.90
Jun-16
Mar-16
Dec-15
Sep-15
Jun-15
Mar-15
Dec-14
Jun-14
Sep-14
2.60
Mar-14
Dec-13
3.20
Jun-13
Sep-13
(per cent)
3.50
Mar-13
Dec-12
Sep-12