Detailed Analysis RBI Rate Cut Feb 2015

Current rates:

1. Bank Rate: 8.75% 
2. Repo Rate: 7.75%
3. Reverse Repo Rate: 6.75% 
4. Cash Reserve Ratio (CRR): 4% 
5. Statutory Liquidity Ratio (SLR): 21.50% 
6. Base Rate: 10.00%–10.25% 
7. Savings Deposit Rate: 4% 
8. Term Deposit Rate: 8.00%–9.00%

In line with market expectations, RBI Governor Raghuram Rajan kept repo rate and CRR unchanged, while cutting SLR by 50 basis points to 21.5% from 22%.

"In order to create space for banks to expand credit, the SLR is being reduced from 22.0 per cent of NDTL to 21.5 per cent. Banks should use this headroom to increase their lending to productive sectors on competitive terms so as to support investment and growth," RBI said.

RBI has indicated that "key to further easing are data that confirm continuing disinflationary pressures. Also critical would be sustained high quality fiscal consolidation...". "Given that there have been no substantial new developments on the disinflationary process or on the fiscal outlook since January 15, it is appropriate for the Reserve Bank to await them and maintain the current interest rate stance," Rajan said while explaining the rationale behind status quo on rates.

"The outlook for growth has improved modestly on the back of disinflation, real income gains from decline in oil prices, easier financing conditions and some progress on stalled projects. These conditions should augur well for a reinvigoration of private consumption demand, but the overall impact on growth could be partly offset by the weaker global growth outlook and short-run fiscal drag due to likely compression in plan expenditure in order to meet consolidation targets set for the year," RBI said. "Domestically, conditions for growth are slowly improving with easing input cost pressures, supportive monetary conditions and recent measures relating to project approvals, land acquisition, mining, and infrastructure. Accordingly, the central estimate for real GDP growth in 2015-16 is expected to rise to 6.5 per cent with risks broadly balanced at this point," the central bank said.

However, it noted that there is improvement in business confidence as visible from a pick-up in new investment intentions, especially in transportation, power and manufacturing. RBI estimated the current account deficit (CAD) for 2014- 15 at 1.3 per cent of the GDP, significantly lower than the earlier projection. "The CAD has been comfortably financed by net capital inflows, mainly in the form of buoyant portfolio flows but also supported by foreign direct investment inflows and external commercial borrowings. Accordingly, there was accretion to India's foreign exchange reserves to the tune of USD 6.8 billion in Q3," RBI said. Raghuram Rajan had surprised markets last month with a 25 basis point rate cut and has hinted at more as prices cool.

The first bi-monthly monetary policy statement for fiscal year 2015-16 is scheduled on Tuesday, April 7, 2015.

Impact of this on various sectors

GDP:

• Accordingly, the central estimate for real GDP growth in 2015-16 is expected to rise to 6.5% with risks broadly balanced at this point.

Agriculture

• According to Rajan, domestic activity is likely to have remained subdued in Q3 of 2014-15, mainly reflecting the shortfall in the kharif harvest relative to a year ago. "Agricultural growth is likely to pick up in Q4 with the late improvement in the north-east monsoon and in rabi sowing," he said. "Nevertheless, growth expectations should be tempered as lead indicators such as tractor and motorcycle sales and slowing rural wage growth all point to subdued rural demand," he cautioned.

Industrial activity:

• Advance indicators of industrial activity - indirect tax collections; non-oil non-gold import growth; expansion in order books; and new business reported in purchasing managers surveys - point to a modest improvement in the months ahead. The improvement in industrial activity in November 2014 was broad- based, but continuing contraction in consumer goods production underscores the persisting weakness in consumption demand (even while raising questions about measurement of production). Giving thumbs up to the government initiatives, Rajan said, "Policy initiatives in land acquisition, as well as efforts underway to unlock mining activity and to widen the space for foreign direct investment in defence, insurance and railways, should create a more conducive setting for industrial revival. Faster clearances are also helping in resuscitating stalled projects. The improvement in business confidence is visible in a pick-up in new investment intentions, especially in transportation, power and manufacturing."

Service sector

• Mixed signals: In the services sector, the purchasing managers' survey indicates slower activity, especially in new orders. However, other indicators of the services sector including foreign tourist arrivals, automobile sales, cargo handled at ports, and railway freight traffic suggest improvement. According to Rajan, the overall growth prospects will be contingent upon a turnaround in investment and a durable improvement in the business climate to complement the upsurge in business optimism. "The sharp reduction in oil prices as well as in inflation is likely to increase personal disposable incomes and improve domestic demand conditions in the year ahead," Rajan said

Impact on inflation

• Inflation dynamics have so far been consistent with the assessment of the balance of risks by the Reserve Bank's bi- monthly monetary policy statements, although with some undershooting relative to the projected path of disinflation. While inflation declined faster than expected due to favourable base effects during June- November, the upturn in December turned out to be muted relative to projections," RBI said. "Augmenting these data with survey data on falling inflationary expectations as well as data on weak commodity prices and muted rural wage growth, the Reserve Bank projected that it would meet its objective of 6% CPI inflation by January 2016. Having committed in public statements to initiate a change in the monetary policy stance as soon as incoming data permitted, the Reserve Bank cut the policy rate on January 15, 2015," Rajan explained. "The upside risks to inflation stem from the unlikely possibility of significant fiscal slippage, uncertainty on the spatial and temporal distribution of the monsoon during 2015 as also the low probability but highly influential risks of reversal of international crude prices due to geopolitical events," he added.