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Monetary Policy Update

Feb 7, 2018

Repo Rate and Policy Tone Maintained at 6% and Neutral Respectively

The Reserve Bank of India today decided to keep the policy repo rate unchanged at 6% in a 5-to-1 vote. Dr. Michael Patra voted for a 25bps hike. The MPC maintained its neutral stance on monetary policy and commitment to achieving a medium-term target for CPI of 4% ± 2%, while supporting growth.

Key highlights

Global Economic Growth Continues Apace

Advanced economies appear in good shape, with better consumption, investment and economic optimism along with falling unemployment and low interest rates supporting the Euro recovery. The U.S. lost some momentum with growth slowing down in Q4CY17 even as manufacturing activity touched a multi-month high in December.

Emerging economies as well accelerated in Q4CY17. China grew above the official target, driven by strong domestic consumption and robust exports though easing fixed asset investment and surging debt levels remain a concern. Russia was driven by consumption, rising oil prices and high exports and Brazil also remained strong.

Net-net, global trade continued to expand, underpinned by strong investment and robust manufacturing activity. Inflation remained contained in most advanced economies, barring the UK, on subdued wage pressures and was divergent in key emerging economies dependent on country-specific factors.

However, Global Financial Markets and Rising Yields Are Concerns

The RBI noted risks related to normalisation of US Fed monetary policy, with payroll data demonstrating wage growth and employment growth, and rising bond yields in the U.S. and other economies. The RBI also flagged the recent episode of volatility in global financial markets.

Domestic Economy Remains Strong

The RBI echoed generally accepted views that manufacturing was boosting industrial production in November, alongside robust growth in cement, and steel. The manufacturing sector has been in an upswing for six months, with a notable rise in new orders.

While there was a slowdown in core sector growth, commercial vehicle sales growth is at an eight year high in December, and cargo, air traffic and passenger data are all supportive of a pickup in economic activity.

The Central Statistics Office (CSO) estimates 6.1% real GVA growth in FY18 from 7.1% in FY17.

RBI Notes Inflationary Concerns, But Less Hawkish Than Expected

Headline CPI increased for the sixth consecutive month in December. However, after rising abruptly in November, food prices have reversed partly in December with prices of vegetables and pulses moderating. Fuel inflation moderated in December, as did inflation in transport and communication.

Organized sector wage growth remains firm, while rural wage growth has decelerated.

Market Reactions

Ten-year yields marginally declined intra-day on the RBI announcement to 7.524% (down -5bps) at the time of this writing. Ten-year yields over the past few weeks have been driven higher by pressures on the Government meeting its fiscal deficit targets and the RBI’s expectations of firming inflation (highlighted in today’s release as well). However, RBI’s expectation that H2FY19 CPI should moderate down to 4.5-4.6%, from its expectation of 5.1% in Mar-18, has likely led to the modest improvement in bond market prices.

Outlook

Three statements by the RBI leave us with the view that this was a generally fair and balanced assessment. First, the RBI termed the pickup in headline inflation in November an unusual pickup in food prices, suggesting it’s not witnessing the recent pickup in inflation as a sustained, worrisome acceleration.

Second, the RBI mentioned that rising input costs are likely to be passed on to consumers. From, an equity investor perspective, that’s in line with our view that we are in an environment of moderate inflation and earnings growth, and margins will likely be preserved.

Third, the economy is on a recovery path, with early signs of a revival in investment activity. Again, this aligns generally with our view and we are heartened that the RBI thinks we’re generally early in the cycle.

We view the current monetary policy statement as a positive on the margin. With markets on edge, the RBI wanted to ensure it did not further create causes for alarm.

Inflation

Consequently, the MPC expects 5.1% in quarter ending Mar-18. For H1FY19, the MPC expects CPI to range between 5.1-5.6%, declining to 4.5-4.6% in H2FY19. The committee highlighted six upside risks inflation:

• The staggered impact of HRA increases
• Higher commodity prices due to strong global supply-demand dynamics
• Revised guidelines for minimum support prices of kharif crops
• An increase in customs duty on a number of items
• Impact of fiscal slippage on inflation.
• Normalisation of global monetary policy.

In terms of growth projections, the RBI estimates its real GVA projection for FY18 at 6.6%, FY19 at 7.2%.

The next meeting of the MPC is scheduled on 05-Apr-18.

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