RBI's bi-monthly monetary policy: Instead of a rate cut, analysts expect these changes

Reserve Bank of India (RBI) governor Urjit Patel along with Monetary Policy Committee (MPC) is set to present the second-bi monthly policy for financial year 2017-18 on afternoon of June 7, 2017.

Many analysts expect a status quo on policy rate with a widening in liquidity corridor.

Maintaining its policy stance, RBI kept repo rate unchanged followed by a 25 basis point hike in reverse repo rate at 6% from its previous 5.75% in April monetary policy. 

India's inflation data has been softer than expected, stronger INR against US dollar, softer global commodity prices, fading of El Nino risks, Q4FY17 GDP data to a two-year low, credit growth and capex related indicators exhibiting sustained sluggishness and India’s Balance of Payment dynamics has been comfortable.

Consumer Price Index (CPI) Inflation has cooled sharply recently to 2.99% Year-on-Year (YoY) in April from an average of 4.5% YoY in FY2017, largely on the back of paring of food and core inflation.

source: tradingeconomics.com

Q4 FY2017 GVA growth came in much lower than expectation, printing at 6.1% YoY compared to 6.7% YoY in Q3 FY2017, while GDP growth also declined sequentially to 6.1% YoY from 7.0% YoY in Q3 FY2017.

RBI had projected CPI inflation at 4% and GVA growth by 6.7% at the end financial year 2016-17.

Going ahead, while oil prices have been subdued over the past few months, the Rupee has appreciated by 3.3% against the Dollar over March-May 2017.

Naresh Takkar, Managing Director and Group CEO, ICRA said, “The MPC may choose to observe the actual progress of the monsoon and the adjustment during the transition to the GST, prior to reducing the policy rate or reversing the stance back to accommodative from neutral. Therefore, we expect the MPC to opt for a pause in the June 2017 policy review."

Kamalika Das and  Sumedha DasGupta, analysts of ICICI Bank said, "Since only one month’s inflation data for the current fiscal (April 2017) will be available when the MPC meets, the Committee may refrain from changing its stance on inflation. However, any further soft prints on both the inflation and growth fronts may give the MPC occasion to re-evaluate their policy stance."

source: tradingeconomics.com

The duo added, "Given the fact that RBI have been significantly hawkish even till the April policy, it is unlikely that they will substantially lower their vigilance on CPI, especially given that H2 FY2017 is likely to be fraught with several events which may cause volatility to the baseline inflation path."

Meanwhile, analysts at Axis Direct said, "RBI could look at falling core inflation from a different perspective and utilize the available real rate space."

Some measurement on the performance of liquidity in the banking system can be expected. 

State Bank of India (SBI) said, “A widening of the corridor or a signal on the Standing Deposit Facility (SDF) will be a well thought and pragmatic move to push the yields down and ensure monetary policy transmission against the backdrop of significant liquidity overhang in the system.”

Net absorption of liquidity from banking system has been declining and is at Rs 57,300 crore by end of May 2017 compared to Rs 1,06,700 crore in April 2017 and Rs 1,84,000 crore in March 2017. 

As on June 02, 2017, reverse repo flows stands at Rs 402,612 crores. Care Ratings said, "Therefore, a decrease in Cash Reserve Ratio (CRR) from the current level of 4% seems unlikely."

Also, money circulated in the economy has increased but has not reached the levels of pre-demonetization. In fact, it has declined by 14% to Rs 14.07 lakh crore in April 2017 as compared to Rs 16.48 lakh crore in the corresponding period last year.

ICICI Bank said, "We expect some liquidity management measures to be announced in the August policy, if not in the upcoming one."