Aug 3, 2017
The Reserve Bank of India today decided to cut the policy repo rate by 25bps to 6% in an “effective” 5-to-1 vote. 4 voted for a 25bps cut, Dr. Ravindra Dholakia for a 50bps cut and Dr. Michael Patra for status quo.
The MPC maintained its neutral stance on monetary policy and achieving a medium-term target for CPI of 4% ± 2%, while supporting growth.
Accordingly, the Reverse Repo adjusted to 5.75% and the MSF and Bank Rate adjusted to 6.25%.
Strengthening Developed Economies, while Emerging Economies Mixed
Amidst general tightening monetary policy moves in developed foreign nations, the U.S. and Japan demonstrated improved economic health. Inflation though remains well below target in most Advanced Economies. On the emerging front, China, Russia, Brazil and South Africa remain mixed in terms of current as well as future economic potential with inflation subdued these economies. Net-net, global demand and trade have exhibited improvement.
RBI’s Shifting Stance on Inflation and the Economy
The RBI highlighted the brightening prospects for rural demand, acknowledging a favorable monsoon, strong kharif sowing season and likelihood of achieving production targets. On the flip side, the RBI acknowledged weakening industrial performance and sluggish urban demand. While transportation was a bright light, manufacturing activity heading into contraction and deceleration in the output of infrastructure goods was flagged as a concern. The RBI’s focus shifted this month away from inflation targeting towards supporting growth.
Current Domestic Macro Conditions Warrant Rate Cut
A normal monsoon, smooth implementation of GST and a significant cooling of inflation ex. food and fuel made it an opportune time for the MPC to cut the repo rate by 25bps. Further, an expected adequate supply of crops will lend a stable hand to cool any potential price spikes.
The capex cycle remained relatively weak, stalled infrastructure and investment projects did not gain traction, output of infrastructure goods decelerated and the corporate sector continued to deleverage. The output of core industries dragged and the PMI for manufacturing has weakened. All of these were highlighted by the MPC in building the case for a rate cut. In addition, pricing power polled in the Reserve Bank’s industrial outlook survey and in manufacturing and services PMIs still remained subdued.
Uptick in the 10 Year
Ten-year yields increased to 6.46% by the close of day from 6.44% with significant upward volatility immediately post the RBI release. We believe this reflects the RBI’s acknowledgement of a sloping up inflation trajectory going forward.
Overall, the MPC noted that the trajectory of inflation is expected to rise from current lows. Hence, the policy stance was maintained at neutral. The projection of real GVA growth for FY18 has been retained at the Jun-17 projection of 7.3%, with risks evenly balanced.
The CPI outlook hinges on several factors: the implementation of the house rent allowances (HRA) under the7th central pay commission (CPC); the impact of the price revisions withheld ahead of the GST and farm loan waivers which could compel cutbacks on state capital expenditure.
The RBI has additionally taken several initiatives on fiscal management and deepening of the credit and fixed income markets. The RBI has focused on:
The next meeting of the MPC is scheduled on 4-Oct-17.
It is evident from the commentary that the RBI is now keenly focused on the urgent need to reinvigorate private investment, kick-start bank credit, remove infrastructure bottlenecks and push the agenda for housing for all.
The RBI’s shift in focus from inflation to growth marks a notable shift in policy. Services remains in growth mode and the rural consumer appears to be stabilizing. The RBI and government are keenly focused on reviving private investment. Early reports on earnings are coming along expected lines, with strength in Financials, and weakness in Pharma and IT. We continue to remain of the view that the economy is in the middle innings of a recovery.