Taking careful cognizance of imponderables impacting local and global economic environment the Reserve Bank of India (RBI) on Tuesday preferred to hold its rate actions to get greater clarity from parameters influencing inflation and growth as also from the government’s annual budget due in a few weeks.
Leaving repo rate and reserve requirement for banks unchanged, the RBI cited a variety of factors that could potentially derail growth, investment and inflation targets. While exuding confidence of meeting January 2016 and March 2017 inflation targets it has set for itself basing it on a normal monsoon and oil prices remaining in the present range, the RBI tampered it with likely impact from pay commission salary increases, and adverse impact of geopolitical events on commodity prices and financial markets.
"Structural reforms in the forthcoming union budget that boost growth while controlling spending will create more space for monetary policy to support growth, while also ensuring that inflation remains on the projected path of 5 per cent by the end of 2016-17," the RBI said.
Governor Raghuram Rajan only last week stressed India must keep fiscal deficit under check and must desist from giving in to temptation to pump-prime the economy. How Finance Minister Arun Jaitley responds will be seen from his budget proposals.
The RBI sounded caution that services sector inflation has remained sticky since Sept 2015 across housing, transport and communication. Household inflation expectations remain elevated and the rate of increase in corporate staff costs picked up. While crediting improved supply management to prices of cereals remaining under control, the RBI highlighted elevated prices of pulses that reflect structural mismatches.
Any future rate cut by the RBI will be conditional on data supporting its decision. Yet, industry keeps clamouring that a rate cut is critical for revival of investments and corporate profitability.
Even as the RBI forecast gross value added (GVA) growth for 2016-17 at 7.6 per cent following 7.4 per cent in 2015-16, it also highlighted segments that could be dampeners.
The current momentum of growth is reasonable, though below what should be expected over the medium term, the RBI stressed.
Jay Shankar, chief India economist at Religare Capital Markets doesn’t expect any rate cuts in FY17, saying upside risks are marginally higher than downside risks.
"The RBI is in 'wait and watch' mode for the budget and what big states are doing with their own state pay commissions. Punjab, UP, West Bengal, Kerala and Tamil Nadu – all election-bound – and Himachal Pradesh have already announced setting up of their respective Pay Commissions," said Jay Shankar.
Stalled projects remain high, and new investment intentions shrank, perhaps on the back of low capacity utilization, the RBI pointed out. Road construction picked up but overall construction activity, cement production, rail freight growth remains weak. Yet, services PMI rose to a 10- month high in December on rising business orders.
Two successive poor monsoons has meant that rural incomes will continue to be supported by allied activities such as dairy and horticulture, which now contribute as much to GDP as food grains.
Weak domestic private investment demand in a phase of balance sheet adjustments, re-emergence of concerns relating to stalled projects, excess capacity in industry, sluggish external demand conditions dampening export growth could act as headwinds. Yet, large positive terms of trade gain, improving real incomes of households and lower input costs of firms could help.
Jonathan Anchen, head of economic research & consulting India at Swiss Re said the RBI would watch out for are the development of inflation and the structural reforms.
"We expect that the RBI will wait for the fiscal numbers to be released in the Budget before taking a decision on rates. After all the governor spoke strongly on this issue only last Friday when he said that more spending may hurt debt dynamics, and that growth multipliers on government spending could be relatively small," said Anchen.
"While the governor felt that it is unfair to read his statements as hawkish, it seems that the RBI is not as dovish as in the previous policy statement."
