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Update on monetary policy, the economy and the new monetary policy framework

Aug 9, 2016

The RBI kept the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.5% today, maintaining an accommodative stance while awaiting developments. The RBI stated it will continue to provide liquidity as required but progressively lower the liquidity deficit in the system to a position closer to neutrality.

The RBI continues to believe they are within the inflation band given by the Government and expect to be around 5% CPI inflation by March 2017, absent unforeseen eventualities.

Thatis good news. A low inflation and declining interest rate environment will add further stability to the currency, increase real returns earned by savers while lowering nominal interest rates paid by borrowers.

RBI’s Quarterly Projection of CPI Inflation (y-o-y) for Q2:2016-17 to Q4:2016-17

RBI's Quarterly Projection of CPI Inflation (y-o-y) for Q2:2016-17 to Q4:2016-17

The RBI reiterated that they did not see the upcoming FCNR(B) repayments as disruptive. The RBI pointed out, though, that despite easy liquidity, banks have reduced lending rates only modestly. Substantial pass through will happen only as corporate credit demand picks up, and public sector banks, strengthened by clean balance sheets, compete for corporate business. The latter, to us, seems some time away.

The RBI Board also selected Dr. Michael Patra to be the RBI Board nominee on the MPC. Going forward, monetary policy will be conducted via the Monetary Policy Committee framework. The other two members from the RBI will be the Governor and the Deputy Governor in charge of monetary policy. With the formation of the MPC, the Government and the RBI have embarked on bringing India’s monetary policy framework in line with contemporary frameworks and put in place a platform for effective decision making.

What we can gather about Dr. Patra is that he was an Adviser-in-Charge of the Monetary Policy Department in the Reserve Bank of India since March 2006. Before moving to the Monetary Policy Department in October 2005, he was Adviser in the Department of Economic Analysis and Policy in charge of international finance, money and banking. He has served in various capacities in the Reserve Bank of India which he joined in 1985. He is a Fellow of the Harvard University where he undertook post-doctoral research in the area of financial stability. He has a Ph.D. in Economics from the Indian Institute of Technology, Mumbai. He has received professional training at the IMF Institute on Financial Programming and Policy and at the Centre for Central Banking Studies, Bank of England.

Outlook: The decision today was widely expected. The selection of Dr. Patra to the MPC seems on the surface to be a laudable choice though we admit we do not know too much about the man. Given his background, one would not be unreasonable in expecting a continuation of Dr. Rajan’s policies. The economy remains on a recovery trajectory. Global headwinds remain; however, things are stabilising. Further out, we are considering the possibility that growth could be picking up in the U.S. as well, which could bring the Fed rate hike back to the fore. This is counter balanced by approaching contentious U.S. elections, but bears watching.

With a good sowing season, we concur with the RBI’s view that the inflation glide path remains in place, albeit with risks to the upside. That is balanced by an improving economy. Net net, this was a relative non-event, and we see no reason to change our outlook as a result. We will have a detailed update on Monday on the state of the economy and the issue on every investor’s minds: valuations.