RBI says policy action should be anticipatory once sufficient data support the policy stance
The Reserve Bank of India (RBI) has reduced the policy repo rate under
the liquidity adjustment facility (LAF) by 25 basis points (bps0 from
7.75% to 7.5% with immediate effect. Meanwhile, the cash reserve ratio
(CRR) of scheduled banks is unchanged at 4.0% of net demand and time
liabilities (NDTL). As per the RBI, the new CPI rebased to 2012 was released on 12 February 2015. Inflation in January 2015 at 5.1% as measured by the new index was well within the target of 8% for January 2015.
RBI indicates that the uncertainties surrounding any inflation projection are, however, not insignificant. As per the RBI, the most significant influences on near-term inflation will be the strength of aggregate demand relative to available capacity.
Regarding the higher than expected fiscal deficit for 2015-16, RBI says government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower.
The need to act outside the policy review cycle is prompted by two factors: First, while the next bi-monthly policy statement will be issued on 07 April 2015 the still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance. Second, with the release of the agreement on the monetary policy framework, it is appropriate for the Reserve Bank to offer guidance on how it will implement the mandate.
Going forward, the RBI will seek to bring the inflation rate to the mid-point of the band of 4 +/- 2% provided for in the agreement, i.e., to 4% by the end of a two year period starting fiscal year 2016-17.
The guidance on policy action given in the fifth-bi-monthly monetary policy statement of December 2014 is largely unchanged. Further monetary actions will be conditioned by incoming data, especially on the easing of supply constraints, improved availability of key inputs such as power, land, minerals and infrastructure, continuing progress on high-quality fiscal consolidation, the pass through of past rate cuts into lending rates, the monsoon outturn and developments in the international environment.
Finally, the central government has signed a memorandum with the Reserve Bank setting out clear inflation objectives for the latter. This makes explicit what was implicit before – that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way. In sum, then, the government intends to compensate for the delay in fiscal consolidation with a commitment to an improvement in the quality of adjustment.
As per the RBI, softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6% in the second half. The fiscal consolidation programme, while delayed, may compensate in quality, especially if state governments are cooperative. Given low capacity utilization and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilize available space for monetary accommodation.
