Monetary and Liquidity Measures

• On the basis of an assessment of the current and evolving macroeconomic situation, it has been decided to: keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.5 per cent;
  
  
•  keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL); and
  
  
•  continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality.

Consequently, the reverse repo rate under the LAF will remain unchanged at 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 7.0 per cent. 

Assessment

** Since the first bi-monthly statement of April 2016, global growth is uneven and struggling to gain traction. World trade remains muted in an environment of weak demand. In the United States, growth was slow once again in Q1 because of contracting industrial activity and exports. Recent indicators of labour market activity have also weakened. In the Euro area, by contrast, Q1 GDP rose strongly on the back of robust consumer spending and recovering employment and business conditions. In Q2 so far, unemployment is falling, albeit slowly, and purchasing managers’ sentiment is upbeat. In Japan, growth surprised on the upside in Q1, with the economy escaping a technical recession, but industrial activity remains weak and deflationary pressures are building.

** GDP growth slowed sequentially in China in Q1, with retail sales, industrial production and fixed investment showing signs of weakness in recent months amidst still rising levels of indebtedness among households and corporations. While macroeconomic stability is returning to some emerging market economies (EMEs), geo-political tensions and high volatility in financial markets impede the resumption of momentum, and the outlook remains challenging. The recent uptick in commodity prices is providing some relief to commodity exporters but political events could 2 unsettle investor sentiment and consequently, capital flows could turn volatile again. For commodity importers, net terms of trade gains are moderating.

** On the domestic front, the recently released provisional estimate of gross value added (GVA) for 2015-16 marginally scaled down the annual growth rate to 7.2 per cent, on a deceleration of services sector activity in relation to the advance estimates. There was, however, a sequential pickup in activity in Q4 in line with expectations. As regards the current financial year, the India Meteorological Department (IMD) has forecast an above-normal and well-distributed south west monsoon as El Nino wanes – albeit with a slightly delayed onset. Realisation of this prediction is critical for the outlook for agriculture since reservoir levels have been depleted to 17 per cent of capacity – 40 per cent lower than the level a year ago. Even though rabi procurement was lower in April-May 2016 than a year ago, midMay food stocks at 58 million tonnes were almost three times the norm for Q1.

** CPI inflation excluding food and fuel edged up in April, driven by prices of petrol and diesel embedded in transport and communication. Clothing and footwear also registered moderate increases in inflation. Services inflation remained elevated on account of house rents, water charges, tuition fees and taxi/auto fares. Excluding petrol and diesel from this category, inflation was sticky and above 5 per cent. However, since growth in rural wages and corporate staff costs have been modest, cost-push factors may be subdued for the time being.

**In its bi-monthly monetary policy statement of April 2016, the Reserve Bank stated that it would watch macroeconomic and financial developments in the months ahead with a view to responding as space opens up. Incoming data since then show a sharper-than-anticipated upsurge in inflationary pressures emanating from a number of food items (beyond seasonal effects), as well as a reversal in commodity prices. A strong monsoon, continued astute food management, as well as steady expansion in supply capacity, especially in services, could help offset these upward pressures. Given the uncertainties, the Reserve Bank will stay on hold, but the stance of monetary policy remains accommodative. The Reserve Bank will monitor macroeconomic and financial developments for any further scope for policy action.

The third bi-monthly monetary policy statement will be announced on August 9, 2016.