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Repo Rate Cut by 25bps, Policy Tone unchanged at “Neutral”

Apr 4, 2019

The Reserve Bank of India today decided to reduce the policy repo rate to 6.00% from 6.25% with four out of six members voting in favour of the cut. However, the MPC decided to keep the monetary policy stance unchanged at “neutral” 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 guided for a significant fall in headline inflation:

• 2.4% for Q4FY19 (vs. expectation of 2.8%)
• 2.9-3.0% for H1FY20 (vs. expectation of 3.2-3.4% earlier)
• 3.5-3.8% for H2FY20 (vs guidance of 3.9% in Q3FY20)

The GDP growth rates expectations trimmed down:

• 6.8-7.1% for H1FY20 (vs 7.2-7.4% earlier)
• 7.2% in FY20 (vs 7.4% earlier)

Rationale for a Rate Cut

In listing its rationale for a rate cut, the RBI flagged slowdowns in global economic activity, declining factory output in US, soft domestic demand and contracting manufacturing activity in Euro Area as well growth slowdowns in major emerging market economies (EMEs). In China, growth decelerated in Q4CY18 on subdued domestic and global demand impacting industrial activity.

Domestically, the Central Statistics Office has revise down FY19 GDP growth estimate from 7.2% to 7.0%. Domestic economic activity decelerated due to a slowdown in consumption, both public and private possibly reflecting tight liquidity and availability of credit.

The index of industrial production (IIP) growth slowed down to 1.3 per cent in Jan-2019 due to automobiles, pharmaceuticals, and machinery and equipment. Growth in eight core industries has remained sluggish in February. The manufacturing purchasing managers’ index remained in expansion zone for the 20th consecutive month in March.

Lead indicators for the sub-segment of transportation, sales of commercial vehicles, port freight traffic and international air freight traffic witnessed contraction, while hotels occupancy and foreign tourist arrivals in January and international air passenger traffic showed some improvement.

On the financing side, net FDI inflows were strong in April-January 2018-19. Foreign portfolio investors turned net buyers in the domestic capital market in Q4FY19. India’s foreign exchange reserves were at USD412.9 bn as on March 31, 2019.

Market Reaction

• Yield on the 10 year Government bonds was largely unchanged post the MPC announcement, at 7.32% (up 5 bps intraday) even as the GDP growth forecasts have been revised down. Further, the commentary was perceived as neutral against market expectations of more dovish commentary. Yields have come off meaningfully from 8.18% levels seen in September-18.
• The Indian rupee depreciated 58 paise to trade at 69.0 per Us dollar.

Outlook

Neutral stance with likelihood of further rate cuts on economic weakness

Even as inflation projections have been revised downwards significantly and some of the risks pointed out in the last resolution have been mitigated, several uncertainties still cloud the inflation outlook.

The domestic and global demand-supply balance of key food items is expected to remain favourable, and the short-term outlook for food inflation remains benign. However, early reports suggest some probability of El Niño effects in 2019 which could lead to upwards pressure on prices. The outlook on crude continues to weigh as well, as Brent prices are threatening to cross the $70 level. Therefore, the RBI chose to maintain a neutral stance for now. It remains to be seen if the benefits of rate cuts are passed on to the end consumers in the form of lower cost of capital.

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