Mumbai: The Reserve Bank of India (RBI) on Tuesday left policy rates unchanged at its final monetary policy review for 2015, even as it confirmed that an economic recovery was on, and appears “sustainable".

The central bank’s views on the economy come a day after the government released data that showed that gross domestic product (GDP) in the second quarter of 2015-16 expanded at the rate of 7.4% on the back of a pick-up in investment demand.

Following Tuesday’s review, the benchmark repo rate, or the rate at which RBI lends money to banks, remains unchanged at 6.75%. Since January, RBI has cut rates by 125 basis points. One basis point is one-hundredth of a percentage point.

The cash reserve ratio (CRR), or the portion of a bank’s deposits that has to be maintained in cash with RBI, stands unchanged at 4%. The statutory liquidity ratio (SLR), which is the amount that banks hold in government bonds, also remains steady at 21.5%.

All 10 analysts polled by Mint expected a status quo policy.

The RBI’s last review of 2015 capped a year in which interest rates have seen the steepest reduction since the global financial crisis.

Will there be more rate cuts?

RBI governor Raghuram Rajan indicated that this depends on the effects of the Seventh Pay Commission recommendations on the government’s fiscal math and inflation remaining low.

Most economists do not expect any more easing until the Union Budget in February.

RBI’s view that the economy is in the “midst of a recovery" could also reduce urgency for more monetary stimulus, they point out.

The RBI itself gave few hints of further rate cuts except to say that the central bank remains “accommodative" in its stance.

“The Reserve Bank will use the space for further accommodation, when available, while keeping the economy anchored to the projected disinflation path that should take inflation down to 5% by March 2017," the central bank said in its statement.

“Today’s policy undertone has leaned towards the neutral-to-dovish side. The governor’s indication of being accommodative sends a positive signal for the Indian economy," said Arundhati Bhattacharya, chairperson of State Bank of India, in an emailed statement.

Others differed. The bar for further rate cuts, though not impossible, is high, said Pranjul Bhandari, chief India economist at HSBC.

In its policy statement, RBI said there was a downside bias to its retail inflation forecast of 5.8% by January 2016, while adding it will track developments on commodity prices, household inflation expectations and the impact of the Seventh Pay Commission proposals closely.

The central bank, however, said it expects that the direct impact of the pay commission report on aggregate demand in the economy to be offset by the government’s plan to reduce its fiscal deficit to 3.5% next year.

“I am hoping that the government is able to maintain and enhance the quality of the budget. We don’t feel there would be a significant effect on aggregate demand so long as the government maintains its fiscal path," said Rajan in a press conference after the policy announcement.

In a conference call with analysts, Rajan said RBI may look through the “technical" impact of higher house rent allowance (HRA) built into the pay commission recommendations unless it has a broader impact on the rental market.

House rents are a component of the consumer price inflation (CPI) index.

The markets saw these statements as dovish.

“While the status quo was as expected, comments by the governor have been rather dovish on inflation," said Jayesh Mehta, country treasurer, Bank of America-Merrill Lynch (BofA-ML).

Bond yields eased and the 10-year benchmark yield ended 6 basis points (bps) lower at 7.72% on Tuesday. The rupee closed 0.26% stronger at 66.49/$.

Equity markets ended flat. The benchmark BSE Sensex closed at 26,169, up 23 points or 0.09%.

The conclusion: there may be some more monetary easing in 2016, especially if inflation stays low and government presents a tight Union Budget in February.

Is growth back?

RBI struck a positive note, saying that the economy is in the midst of a recovery.

“While urban consumption is showing signs of a pick-up in some areas, such as passenger vehicles sales, rural demand has been weakened by two consecutive deficient monsoons and slowing construction activity. Nevertheless, new project announcements as measured by the Centre for Monitoring Indian Economy, grew more strongly in the second quarter," said RBI, adding that whether higher public investment can lead to a pick-up in private investment still remains to be seen.

GDP data released on Monday showed that the economy grew at 7.4% in the second quarter of the fiscal compared to 7% in the first quarter. Gross fixed capital formation, an indicator of investment demand, showed growth of 6.8% from a year ago, indicating some pick-up. Private consumption also increased by 6.8% from a year ago.

The central bank’s deputy governor Urjit R. Patel said that the data shows the economy is on a recovery path which looks “sustainable". RBI has kept its growth forecast unchanged at 7.4% for 2015-16.

The conclusion: the RBI thinks things have improved but not enough to revise its growth rate upward.

Will banks be pushed to pass through more of the rate cuts?

While no further rate cuts are expected from RBI in the next few months, the central bank is hopeful that banks will pass on more of the rate cuts announced earlier in the year.

The median base lending rate of banks has only fallen by 60 bps in response to the 125 bps in rate cuts from RBI, the central bank pointed out.

Rajan said that RBI will nudge the banks to lower loan rates by reworking the marginal cost of funds method which banks will use to arrive at their base rate.

“The Reserve Bank will shortly finalize the methodology for determining the base rate based on the marginal cost of funds, which all banks will move to. The government is examining linking small savings interest rates to market interest rates. These moves should further help transmission of policy rates into lending rates," RBI said.

Bankers agreed that these two measures, along with benefits from recently lowered deposit rates, would pull base lending rates down over the next quarter.

“Typically any deposit rate cut takes nearly six months to a year before reflecting in deposit cost for banks. In about three or four months, we should see more base rate cuts by banks," said R.K. Takkar, managing director and chief executive, UCO Bank.

The country’s largest lender, State Bank of India, however, stayed away from a commitment towards lower rates.

“The guidelines on the base rate calculation based on Marginal Cost of funds will be watched and appropriate actions will be taken on the same," said Bhattarcharya.

The conclusion: RBI will push banks to transmit more of the rate cuts announced in 2015 and they probably will.

What about bad loans?

The RBI governor also urged banks to continue cleaning up their balance sheets by reducing the level of stressed assets.

Rajan says that he hopes that banks would have done enough to clean up their books by March 2017, and added that the regulator will ensure that tools given to banks to reduce stressed assets are not misused.

The RBI has allowed banks to extend the tenure of infrastructure loans up to 25 years. It has also permitted lenders to convert their debt into a majority equity holding in cases where restructuring has failed to work.

“The RBI will monitor the use of these schemes continuously to ensure they are used in the right manner," said Rajan. He did not elaborate on how the government’s proposed scheme for revitalizing state discoms (state-owned electricity distribution companies) will help banks. The power sector is one of the biggest sources of stressed assets for lenders.

In November, power minister Piyush Goyal announced the Ujwal Discom Assurance Yojana (UDAY) to improve the debt position of the stressed distribution companies in India.

The proposed scheme allows state governments to take over 75% of the debt of distribution companies and pay back lenders by issuing bonds.

Still, growth itself is the best cure, said Takkar.

“As the economy continues improving, stressed assets will come down and demand will improve, which will lead to more interest rate reductions," he said.

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