1. Narrowing policy corridor, raising reverse repo rate surprising

Narrowing policy corridor, raising reverse repo rate surprising

We believe that rates will remain on hold till the end of 2016

By: | Published: April 6, 2016 12:26 AM

The Reserve Bank of India (RBI) on Tuesday cut the repo rate by 25 bps to 6.5%, in line with consensus and our expectations.

However, it surprised by narrowing the policy corridor from 100 bps to 50 bps, and also by raising the reverse repo rate by 25 bps to 6%.

According to the central bank, a narrower corridor will ensure a “finer alignment of the weighted average call rate (WACR) with the repo rate.”

Also, on liquidity, the RBI 1) lowered the minimum daily cash balance to be maintained by banks from 95% to 90% (with effect from April 16, 2016); 2) reduced the MSF rate by 75 bps to 7%; and 3) stated that it will ensure that durable liquidity in the system is closer to neutral versus an earlier deficit of 1% of NDTL.

All these measures, along with a narrower corridor, are expected to aid in policy transmission.

The RBI left its growth and inflation projections unchanged. It expects GVA growth to rise to 7.6% in FY17 (from 7.3% in FY16) with balanced risks and projects CPI inflation to trend towards the 5% target by March 2017.

In its forward guidance, the RBI stated that “the stance of monetary policy will remain accommodative. The Reserve Bank will continue to watch macroeconomic and financial developments with a view to responding with further policy action as space opens up”.

Despite the RBI’s accommodative policy stance, we believe that rates will remain on hold till end-2016, because we do not forecast the CPI inflation undershooting 5% on a sustained basis. Instead, the focus will now likely be on greater transmission by ensuring adequate liquidity in the banking system.

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