The fifth bi-monthly monetary policy review for FY 2019-20 saw the Reserve Bank of India (RBI) keeping the repo rate unchanged at 5.15 percent, while continuing the existing 'accommodative' monetary policy stance. 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 keep the policy rate unchanged and continuing the existing monetary policy stance.
RBI's Views on Inflation and Growth
In the October 2019 policy review, the CPI inflation was projected at 3.4 per cent for Q2:2019-20, 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1:2020-21 with risks evenly balanced. The actual inflation outcome for Q2 evolved broadly in line with projections – averaging 3.5 per cent. The inflation for October came out much higher than expected.
The Central Bank has put forth the following factors that will guide inflation during 2019-20:
•The upsurge in prices of vegetables is likely to continue in immediate months; however, a pick-up in arrivals from the late kharif season along with measures taken by the Government to augment supply through imports should help soften vegetables prices by early February 2020.
• The incipient price pressures seen in other food items such as milk, pulses, and sugar are likely to be sustained, with implications for the trajectory of food inflation.
• The 3-month and 1-year ahead inflation expectations of households polled by the RBI have risen and these latent sentiment upsides are being reflected in other surveys as well.
• The domestic financial markets have exhibited volatility.
• The domestic demand has slowed down, which is being reflected in the softening of inflation excluding food and fuel.
• The crude oil prices are expected to remain range bound, barring any supply disruptions due to geo-political tensions.
Taking into consideration these factors, the CPI inflation projection is revised upwards to 5.1-4.7 per cent for H2:2019-20 and 4.0-3.8 per cent for H1:2020-21, with risks broadly balanced.
In the October policy review, GDP growth for 2019-20 was projected to be in the range of 6.1 -5.3 per cent in Q2:2019-20 and in the range of 6.6-7.2 per cent for H2:2019-20 – with risks evenly balanced, and 7.2 per cent for Q1:2020-21. The GDP growth for Q2:2019-20 turned out to be significantly lower than projected. Insights from the GDP growth figures for Q2:2019-20 are as follows:
• The various high frequency indicators suggest that domestic and external demand conditions have remained weak.
• The business expectations index of the RBI's industrial outlook survey indicates a marginal pickup in business sentiments in Q4.
• Positive impact of monetary policy easing since February 2019 and the measures initiated by the Government over the last few months are expected to revive sentiment and spur domestic demand.
Taking these factors into consideration, the GDP growth for 2019-20 is revised downwards from 6.1 per cent in the October policy to 5.0 per cent – 4.9-5.5 per cent in H2 and 5.9-6.3 per cent for H1:2020-21. The improved monetary transmission and a quick resolution of global trade tensions are possible upsides to growth projections, whereas a delay in revival of domestic demand, further slowdown in global economic activity and geo-political tensions are downside risks.
The MPC recognises that there is space for future action in monetary policy. However, given the evolving growth-inflation dynamics, the MPC felt it appropriate to take a pause at this juncture. Accordingly, the MPC decided to keep the policy repo rate unchanged and continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
The MPC notes that economic activity has weakened further and the output gap remains negative. However, several measures already initiated by the Government and the monetary easing undertaken by the Reserve Bank since February 2019 are gradually expected to further feed into the real economy. Data on corporate finance and on projects sanctioned by banks and financial institutions suggest some early signs of recovery in investment activity, though its sustainability needs to be watched closely. The need at this juncture is to address impediments, which are holding back investments. The introduction of external benchmarks is expected to strengthen monetary transmission. In this context, there is also a need for greater flexibility in the adjustment in interest rates on small saving schemes.
In the judgement of the MPC, inflation is rising in the near-term, but it is likely to moderate below target by Q2:2020-21. It is, therefore, prudent to carefully monitor incoming data to gain clarity on the inflation outlook. Similarly, the forthcoming union budget will provide better insight into further measures to be undertaken by the Government and their impact on growth.
The RBI's unexpected hold on the policy rate cuts in the current scenario where the GDP data shows a sharp slowdown has shocked the markets. However, RBI has stated it will continue with the 'accommodative' stance and keep an eye on the inflation target with emphasis on reviving the growth.
With RBI now playing wait and watch, the ball is now with the Government of India to consolidate the growth momentum and revive the economy in the upcoming budget.
We advise our investors to stay invested.
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