Credit Policy Review - April 2016

In line with consensus expectations RBI cut the repo rate by 25 bps from 6.75% to 6.5% and in an unexpected move narrowed the policy rate corridor from +/-100 bps to +/- 50 bps. Thus the MSF (marginal standing facility) rate stands reduced to 7% while the reverse repo rate is adjusted to 6%. As per RBI a narrower corridor will ensure “finer alignment of the weighted average call rate with the repo rate.”

In a major development RBI announced changes in its liquidity framework wherein systemic liquidity would be progressively improved from a deficit of 1% of NDTL (Net demand and time liabilities) to a position closer to neutral. RBI also reduced the minimum daily maintenance of cash reserve ratio (CRR) from 95% of the requirement to 90% for the banks (keeping CRR unchanged) with effect from the fortnight beginning April 16, 2016.

The RBI kept its growth and inflation projections unchanged. It expects GVA (gross value added) growth to rise to 7.6% in FY17 (from 7.3% in FY16) with balanced risks and projects CPI inflation to trend towards the 5% target by March 2017.

“In its forward guidance, the RBI stated that “the stance of monetary policy will remain accommodative. The Reserve Bank will continue to watch macroeconomic and financial developments in the months ahead with a view to responding with further policy action as space opens up.”

Source: First Bi-monthly Policy Statement for the year 2016-17


Conclusion and Outlook

While the repo rate cut in the credit policy review was along expected lines, the proposed changes in liquidity framework are a significant policy regime shift which should have material positive impact on yields going forward.

RBI has reaffirmed that the stance of monetary policy will remain accommodative. It has emphasized that current and past rate cuts need to transmit to lending rates. The introduction of marginal cost of funds based lending rate (MCLR), reduction in small savings rates and the changes in liquidity management framework will improve monetary policy transmission and magnify the impact of the rate cut.