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RBI Policy – Monetary Policy Doing the Job, Fiscal Policy Intervention Needed

Aug 7, 2019

The Reserve Bank of India today decided to reduce the policy repo rate to 5.40% from 5.75%. While, all the six members of the MPC were in favour of a rate cut, two members voted for a 25bps rate cut and four members voted for a 35bps rate cut. The MPC decided to keep the monetary policy stance unchanged at “Accommodative” with an objective of achieving a medium-term target for CPI of 4% within a band of ± 2%, while supporting growth.

Key highlights of the RBI’s Monetary Policy

The MPC’s inflation expectations remain broadly unchanged:

• 3.1% for Q2FY20 (vs. expectation of 3.0-3.1% earlier)

• 3.5-3.7% for H2FY20 (vs guidance of 3.4-3.7% earlier)

• 3.6% for Q1FY20

The GDP growth rates expectations trimmed down:

• 5.8-6.6 for H1FY20 (vs 6.4-6.7% earlier)

• 7.3-7.5% for H2FY20 (vs 7.2-7.5% earlier)

• 6.9% in FY20 (vs 7.0% earlier)

Rationale for a Rate Cut

In listing its rationale for a rate cut, the RBI flagged a slowdown in global economic activity, elevated trade tensions and geo-political uncertainty. GDP growth has decelerated in the U.S. and Euro area and Japan. Growth in emerging market economies too was pulled down mainly by slowing external demand. The Chinese economy has decelerated to a multi-year low in Q2, while in Russia subdued economic activity continued owing to slowing exports and retail sales.

Slowing Domestic Activity

Domestically, cumulative rainfall is 6% below the long term average with a forecast of normal rainfall for the remainder of this season. IIP has moderated in May pulled down by manufacturing and mining while electricity demand has picked up. The growth in the index of eight core industries decelerated in June, dragged down by a contraction in petroleum refinery products, crude oil, natural gas and cement. However, the purchasing managers manufacturing index inched up to 52.5 in July from 52.1 in June underpinned by a pick-up in production, higher new orders and optimism on demand conditions in the year ahead.

High frequency indicators of services sector activity for May-June present a mixed picture. Tractor and motorcycle sales – indicators of rural demand – continued to contract. Amongst indicators of urban demand, passenger vehicle sales contracted for the eighth consecutive month in June. However, domestic air passenger traffic growth turned positive in June after three consecutive months of contraction. PMI Services showed a multi month high and a clear uptick in activity.

Net FDI inflows moderated during April-May’ 2019. July onwards we have seen steep outflows. India’s foreign exchange reserves were at USD429 bn as on Aug 02, 2019.

Market Reaction

• The yield on the 10 year government bond is flat today. The yield has come off by almost a percentage point in the last three months

• The Indian rupee appreciated marginally to 70.7 per Us dollar.

Outlook

Fiscal & Monetary Policy Starting to Align

While the RBI has been ensuring surplus liquidity in the system and lowering interest rates, the markets have sold off due to disappointments with the budget, tax policy and the lack of a stimulus package for the slowing consumer. Recent indications suggest that the Finance Ministry is far more engaged with the investor committee. This was one of our key concerns during July, and also one of the key reasons for the rapid deterioration in sentiment.

It was positive news on the fiscal front that has arrested the decline in stocks this week. Continued progress on this front will bring comfort to the markets. Should the Finance Ministry disappoint on pro-growth measures, then markets could witness fresh bouts of selling.

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