The second bi-monthly monetary policy review for FY 2019-20 saw the Reserve Bank of India (RBI) reducing the repo rate by 25 basis points from 6.0 percent to 5.75 percent, while changing the monetary policy stance from 'neutral' to 'accommodative'. These decisions are in line with the medium-term target of 4 percent consumer price inflation (CPI), within a band of +/- 2 percent, while supporting growth. This policy meet saw all 6 members of the monetary policy committee (MPC) unanimously deciding to reduce the policy rate and change the monetary policy stance.
RBI's Views on Inflation and Growth
In the April policy review, the CPI inflation was projected at 2.4 per cent for Q4:2018-19, 2.9-3.0 per cent for H1:2019-20, and 3.5-3.8 per cent for H2:2019-20, with risks broadly balanced. The actual inflation outcome in Q4 at 2.5 per cent was largely in alignment with the April policy projections.
The Central Bank has put forth the following factors that will guide inflation during 2019-20:
•The summer pick-up in vegetables prices has been sharper than expected, it might be accompanied by a corresponding larger reversal during autumn and winter. There is also a broad-based pick-up in prices in several food items, which in turn, means that there will be an upward bias to the near term trajectory of food inflation.
• The significant weakening of domestic and external demand conditions led to a sharp broad-based decline of 60 bps in inflation excluding food and fuel in April. This has imparted a downward bias to inflation trajectory for the rest of the year.
• Crude prices have been volatile consistently but the impact has been muted due to incomplete pass-through.
• The near-term inflation expectations of households have continued to moderate.
Taking into consideration these factors, the impact of recent policy rate cuts and expectations of a normal monsoon in 2019, the path of CPI inflation is revised to 3.0-3.1 per cent for H1:2019-20 and to 3.4-3.7 per cent for H2:2019-20, with risks broadly balanced.
In the April policy, GDP growth for 2019-20 was projected at 7.2 per cent – in the range of 6.8-7.1 per cent for H1, and 7.3-7.4 per cent for H2, with risks evenly balanced. Data for Q4:2018-19 indicate that:
• Domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports
• Weak global demand as a result of escalation in trade wars may further impact India's exports and investment activity
• Private consumption has drastically weakened in rural areas
• Political stability, high capacity utilisation, uptick in business expectations in Q2, buoyant stock market conditions and higher financial flows to the commercial sector are all positive indicators for investment activity.
Taking these factors into consideration, the GDP growth for 2019-20 is revised downwards from 7.2 per cent in the April policy to 7.0 per cent – in the range of 6.4-6.7 per cent for H1:2019-20 and 7.2-7.5 per cent for H2 – with risks evenly balanced.
The MPC is clearly concerned about the slowdown in growth as can be seen from its concluding remarks:
The MPC notes that growth impulses have weakened significantly as reflected in a further widening of the output gap compared to the April 2019 policy. A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern. The headline inflation trajectory remains below the target mandated to the MPC even after taking into account the expected transmission of the past two policy rate cuts. Hence, there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity, while remaining consistent with its flexible inflation targeting mandate.
The policy document gives a clear direction on where the rates are heading. The Central Bank's decision to change the monetary policy stance clearly indicates that the rates are heading south and this augurs well for the growth momentum of the economy. As for our investors, we continue to be positive on short term funds and would like to take a cautious approach as far as fresh exposures into credit risk funds are concerned.
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