The Reserve Bank of India (RBI) on Tuesday cut the repo rate by 25 basis points (bps) to 6.5% because of prudent fiscal consolidation path envisaged in the Union Budget, softer inflation and the imperative to boost growth.
The RBI also narrowed the policy rate corridor to +/- 50 bps to align market-driven rates closer to the repo rate. Additionally, to manage liquidity conditions, it reduced the minimum daily requirement of the CRR from 95% to 90%.
It lowered the average ex-ante liquidity deficit in the system from 1% of net demand and time liabilities (NDTL) to neutrality, implying greater injection of liquidity.
* We expect another 25 bps cut this fiscal. The RBI’s policy stance remains accommodative, but before wielding the knife, it will monitor growth recovery and watch how things unfold in the money market.
* For 2016-17, we expect CPI to stay soft at 5% on average if the country is blessed with a normal monsoon. Given the excess capacity in industry, fiscal restraint, weak demand and softer commodity and oil prices, the impending Seventh Pay Commission payouts are unlikely to swing inflation away from the RBI’s glide path.
* Policy transmission is likely to improve, although at a slow rate, as tight liquidity conditions restrict the fall in the market-driven rates. We believe 2016-17 should see faster rate-cut transmission as the average borrowing cost of banks comes down.
* Divergent monetary policies across the world could trigger capital volatility. But a low current account deficit and improving macroeconomic conditions are likely to attract higher inflows relative to the previous year.
* We expect the GDP growth to rise to 7.9% in 2016-17, assuming a normal monsoon. In comparison, the RBI’s growth forecast is at 7.6% for the current fiscal and its inflation target stands at 5% for March 2017.