Scroll Down

Monetary Policy Update

Oct 5, 2016

Policy Action: Rate cut by 25bps to 6.25%; Accommodative stance continues

Under the first review of the newly formed Monetary Policy Committee (MPC) of the RBI, key policy repo rate was cut by 25bps to 6.25%; which was decided unanimously by all the 6 members.

The policy tone remains accommodative, with the MPC reiterating the CPI target of 5% by Mar’17 (though with lesser upside risks vs. previous policy meet); while the medium term CPI target remains at 4% within a band of ±2%.

The next bi-monthly monetary policy statement is scheduled for December 7, 2016.

Key factors: Global and domestic markets, real interest rates and rate cut transmission

The policy statement takes into account several factors such as the projected slowdown in global economy and the uncertainties stemming from Brexit and the upcoming US elections. Globally, commodity prices have firmed up slightly fueled by recent announcement of OPEC potential supply cut.

Domestic agricultural activity has picked up with the monsoons nearly on-par with long-term average levels; helping kharif crop acreage grow healthily.

CPI cooled down in Aug’16 to 5.0% post a “temporary” spike to 6.1% in Jul’16, driven by a drop in food inflation.

With the real interest rate prior to the current policy meet stacking up to 1.5%, with global real interest rates yielding negative, the MPC reckoned a 25bps cut, reducing the domestic real interest rate “realistically” in light of the anemic global real rates.

While the RBI has cumulatively cut policy rate 175bps since Jan’15 (incl. present 25bps cut), transmission by the banks yet remains to be seen.

  • However, it is encouraging that the OMO purchases by the central bank (amounting to the tune of Rupees One Lakh Cr. in the current fiscal year) has helped ease liquidity conditions (notwithstanding the FCNR redemptions). This should facilitate drop in bank’s borrowing costs and potential transmission
  • Secondly, a cut in interest rates of the small saving schemes should drive banks to follow suit

Potential room for further cuts in light of possible waning inflation

Outlook: Domestic industrial growth is expected to pick up on account of sustained public investments and boost to consumer spending from the 7th Pay Commission, along with the potential GST implementation.

In terms of inflation targeting, while the RBI has maintained a target of 5% by Mar’17 and a lower 4% over the mid-term (indicating waning inflation), there remains potential room for further cuts keeping the real interest rate range in focus. We highlight this shift from the previous Governor’s strict inflation targeting practice to potential maintenance of the real interest rate spread.

Agriculture and related sowing activities coupled with the cooling inflation should foster an even more accommodative stance. Transmission by banking system is expected to follow through given the steps implemented so far.


The 10y Indian Govt. Bond yield fell at the close of today’s trading as markets are pricing in expectations of further cooling in inflation over the medium term.

We continue to suggest medium term accrual funds and selective offerings of preference shares as part of the core debt portfolio allocation.