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Monetary Policy Review

Feb 7, 2020

Credit Push to Stressed Sectors, Repo Rate Unchanged

The Reserve Bank of India (RBI) today decided to maintain the policy repo rate at 5.15% amid elevated inflation. The MPC decided to keep the monetary policy stance unchanged as “accommodative” with an objective of achieving a medium-term target for CPI of 4% within a band of ± 2%, while supporting growth.

The RBI has announced significant changes in order to provide relief to stressed sectors like auto, real estate and MSMEs by improving availability of credit at reasonable cost. These measures are expected to act as catalysts to demand revival in these sectors with multiplier effect on other sectors as well.

Key highlights of the RBI’s Monetary Policy

The MPC’s inflation expectations have been revised upwards:

• 6.5% for Q4FY20 (vs. earlier guidance 4.7-5.1% for H2FY20)
• 5.0-5.4% for H1FY21 (vs earlier guidance of 3.8-4.0% for H1FY21)
• 3.2% for Q3FY21

The GDP growth rates expectations were trimmed down again as various high frequency indicators suggest weak demand:

• 5.5-6.0% in H1FY21 (vs. earlier guidance of 5.9-6.3% in H1FY21)
• 6.0% in FY21

Global Economy in the Slow Lane

The RBI flagged slowing economic activity and subdued consumer spending as reasons for subdued global growth. Among advanced economies, GDP growth in the US flattened in Q4 after witnessing an uptick in Q3. In the Euro area, GDP economic activity slowed down as France and Italy shrank unexpectedly. Growth momentum in the UK appears to have weakened in Q4 as reflected in the decline in industrial production and tepid retail sales. With weak global demand pulling down exports and weak retail sales, the Japanese economy lost momentum in Q4.

The Chinese economy slowed down to 29 year low, caused by sluggish domestic demand and prolonged trade tensions. In Russia and Brazil, activity seems to have lost momentum in Q4 with decline in industrial production. While in South Africa, economic activity continued to contract in Q4, pulled down by slump in industrial production and household spending amidst lingering consumer pessimism.

Crude oil and gold prices shot up in early January sparked by the US-Iran confrontation, but both softened from mid-January as geo-political tensions eased.

Domestic Activity on the Path to Recovery

National Statistical Office (NSO) is estimating India’s GDP to grow 5.0% in FY20. While global and domestic economy has slowed down recently, we are now seeing initial signs of revival. Index of industrial production improved in November after contracting in the previous three months. The output of core industries returned to positive territory in December after four months of contraction. Rabi sowing has been higher by 9.5% and high reservoir levels led by above normal monsoon gives us comfort about the rural demand recovery. This is corroborated by the manufacturing purchasing managers’ index for January 2020 which picked up sharply to 55.3 from 51.2 in November on the back of increased output and new orders.

Some of high frequency indicators have turned upwards in the recent period, pointing towards a revival in momentum, however in totality, they give a mixed signal. Tractor sales – indicators of rural demand – grew by 2.4 per cent in December after ten months of a decline though motorcycle sales continued to contract. Domestic air passenger traffic – an indicator of urban demand – posted double digit growth in November, followed by a modest growth in December. On the other hand, passenger vehicle sales continued to contract.

Retail inflation, measured by CPI, shot up to 7.4% in December, the highest reading since July 2014. While food group inflation rose to double digits, the fuel group moved out of deflation. Inflation in CPI excluding food and fuel continued to edge up from its October trough.

While the rate cuts have been significant, with cumulative rate cuts of 135bps since Feb 2019, the concern remains slow transmission of rate cuts to the end consumer. Transmission has gained some momentum, with the weighted average lending rate on fresh rupee loans sanctioned by banks declining 69 basis points.

Export growth continued to contract in Nov-Dec 2019, reflecting the slowdown in global trade. Import growth slumped in Nov-Dec 2019, with contraction in both oil and non-oil non-gold imports. Net FDI inflows rose to USD24.4bn in April-Nov-19 from USD21.2bn a year ago. On the FPI side, the inflows were strong at USD8.6 bn in YTD20 vs a net outflow of USD14.2bn in the same period last year. India’s foreign exchange reserves stood at a very healthy USD471.4 bn as on Feb 04, 2020.

RBI has also set out various measures for improving credit flows to certain stressed sectors:

• No CRR needs to be maintained on any incremental credit given to automobiles, residential housing and MSMEs from Jan 31, 2020 to July 31, 2020, which may ensure high flow of credit to these sectors
• The RBI has permitted extension of the date of commencement of commercial operations of project loans for commercial real estate by another one year without downgrading the asset classification if the project is delayed for reasons beyond the control of promoters
• Pricing of all new loans by banks to medium enterprises will be linked to an external benchmark effective April 1, 2020 which should ensure efficient monetary transmission

Market Reaction

• The yield on the 10-year government bond corrected 5bps. The yields have fallen ~35bps since its near-term peak in mid-December 2019.
• The Indian rupee is trading flat at 71.23 per US Dollar.


The steps taken today very clearly indicate RBI’s focus on improving liquidity in the system to enable banks to kick start the lending cycle. While, the repo rate remained unchanged, measures outside the policy are significant enough to act as catalyst to bring down the rates in the banking system. Autos, Real Estate and MSMEs are struggling with tepid demand currently. The RBI’s focus of targeting sectors undergoing credit crunch should improve flow of credit to such sectors. In our view, this move should set the ball rolling on the demand front with a multiplier effect on other sectors as well. We see demand pick-up and gradual improvement in economic scenario as the most likely path forward.

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