The RBI in its second bi-monthly monetary policy in June 2015 had cut policy (repo) rates by 25 basis points, the third rate cut in 2015. All other policy tools like cash reserve ratio and statutory liquidity ratio remained unchanged in the second review.

RATIONALE FOR RATE CUT IN JUNE-2015

1.       Transmission of Rate Cuts to Consumers: In its monetary policy in April 2015, the RBI had stated that it would not resort to further monetary easing until banks passed on the benefits of the repo cuts during January-March 2015 to consumers in the form of lower lending rates. Consequently, 21 banks cut their base rates (by 15-25 basis points) during April-May. This evidence of monetary transmission of past cuts was among the factors that prompted RBI to cut the repo rate in the second policy review.

2.       Low Inflation Levels: Benign inflation also supported a rate cut. Retail inflation moderated to 4.9% in April 2015 from around 5.2-5.4% during the last three months. The impact of unseasonal rains on prices was rather muted. On a m-o-m basis, food prices rose by just 0.5% in April 2015 as against an average seasonal rise of 1.5% that was witnessed in the same month during the last four years.

3.       Boosting Recovery: Given that inflation remained under control, the RBI chose to support growth as most indicators continued to present a weak recovery. Low capacity utilisation levels, subdued investment and credit growth, an uneven recovery in industrial production and decline in production of core industries in recent months, falling exports, mixed signals from leading indicators of service sector, decline in corporate sales and a weakness in consumption demand supported the case for further monetary easing.

DETERMINANTS OF RBI POLICY RATES

I.        Rainfall Deficit

India recorded a rainfall deficit of 12% during the week ended 22nd July 2015[1]. The country recorded a rainfall of 60.2 mm as against a normal rainfall of 68.1 mm. This was the fourth consecutive week of a deficit rainfall. The IMD stated that rainfall was below normal over the country as a whole.

II. Inflation

The retail price inflation, measured by the Consumer Price Index, rose to 5.4% in June 2015 from 5.0% in May 2015. The rise was mainly accounted for by the rise in food inflation to 5.5%, up from 4.8% a month-ago. In spite of the rise, consumer price inflation is well below the RBI’s target, which is 6.0% by January 2016.

III. Economic Performance

The overall economic performance remains sluggish and the recovery process is still slow, which builds a case for monetary easing. This can be gauged from the various indicators of economic performance.

a. Industrial Production: Industrial production expanded for the seventh consecutive month in May 2015. However, growth slowed down to 2.7% from 3.4% in April 2015 (Annexure). This was also lower than the average growth of 3.7% that was seen during the last six months. .

b. Bank Credit: The y-o-y growth in credit of scheduled commercial bank (SCB) remained sluggish at 9.4% in the fortnight ended 10th July 2015. This is the fourth successive fortnight to witness a sub-10% growth in SCB credit (Annexure).

c.  Investments: The business confidence stands at the highest levels in the last three years, on account of proactive reforms and positive macroeconomic scenario[2]. However, while intentions to invest are strong, investors are still facing challenges while implementing projects. Only 1018 investment proposals were announced during the period Jan-June 2015, valued at Rs. 1745.4 billion (Annexure). Among others, high interest rate has been cited as a major deterrent to new investments.

d.  Trade: India’s exports dropped by 15.8% to US$ 22.3 billion in June 2015. Exports have been declining continuously on a y-o-y basis since December 2014. During the quarter ended June 2015, exports declined by 17.1%. This was the sharpest fall in exports in almost six years. The crash in international crude oil prices, persistent weakness in global demand and a stronger rupee vis-a-vis other currencies have contributed to the sustained weakness in India’s exports. India’s imports also declined in June 2015 by 13.4% on a y-o-y basis on the back of lower gold imports and a continued fall in POL imports (Annexure).

IV.                US Fed Rate Hike Decision

Unlike the US rate hike cycle in 2004-05, India’s rates are unlikely to mirror rising US rates this time around to preserve interest rate differentials. Rate differentials are still near their record high levels. While these favourable and positive differentials allow RBI to keep rates on hold, heightened volatility in the global markets, amid a rising US rate environment is likely to deter RBI to lower policy rates, especially given RBI’s stated logic of Fed rates not being as important a factor as domestic macroeconomic conditions.