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Contrary to consensus and previous MPC meets, a much more vocally engaging RBI prematurely reduced repo rate by 25 bps to 6.25% from 6.5% and softened the stance to Neutral from Calibrated Tightening. Some emphasis was made on the (worryingly) weakening macro which prompted the new Governor in his first innings to go all-out and serve a duet of rate cut AND stance softening.

Monetary Policy Review Feb-2019

CIO’s Desk , February 07, 2019


Contrary to consensus and previous MPC meets, a much more vocally engaging RBI prematurely reduced repo rate by 25 bps to 6.25% from 6.5% and softened the stance to Neutral from Calibrated Tightening. Some emphasis was made on the (worryingly) weakening macro which prompted the new Governor in his first innings to go all-out and serve a duet of rate cut AND stance softening.


  • Voting consensus:

    Note: PD: Dr. Pami Dua, CG: Dr. Chetan Ghate, MP: Dr. Michael Debabrata Patra, VA: Dr. Viral V. Acharya, SD: Shaktikanta Das, RD: Dr. Ravindra H. Dholakia

    • The next meeting of the MPC is scheduled from 02-04-April 19.
    • Global economic health weak: The U.S. and the Euro area continue to weaken with slower economic and industrial activity. Partial government shutdown further clouds U.S Outlook. Emerging economies like China and Russia also lost traction due to growth deceleration and soft oil prices.
    • Domestic economy in sluggishness: FY19 GDP growth came in at 5-yr low; Q4FY19 at 5.8% was also at 20-Q low and both below expectations. GFCF as a % of GDP cracked after 2-years of govt. investment led improvement and IIP got dragged into negative zone by Capital Goods. Consumption growth in GDP looks to be stable so far, but Auto volumes have degrown for 6 months in a row and FMCG companies have complained about weak rural demand impacting volumes. Must agree though that capacity utilization is relatively stable at 75% (above long-term averages) and PMIs in expansion zone for 22-months (though trending down). Latest IMD estimates suggest Normal Monsoon and continuing El Nino conditions.
    • Domestic economy broadly stable: First Advance Estimates (FAE) place FY 18-19 Real GDP at 7.2% featuring acceleration in GFCF, moderation in Consumption Expenditure (both private & public). Net export drag is also expected to moderate. Rabi sowing to pick up by season close, shortages likely to be offset by longer winter led higher wheat yields. capacity utilization at Q2FY19 improved to 74.8% vs. 73.1% in Q1FY19 and PMIs have remained in expansion mode.
    • Real GDP: Going forward, aggregate bank credit and overall financial flows to commercial sector to affect growth outlook. Soft crude prices, impact of rupee depreciation on exports and slowing global demand could pose headwinds to GDP growth.

    Source: MPC Policy Statement, Feb-19

    • Significant inflation cooling: Headline CPI, declined from 3.4% in October 2018 to 2.2% in December 2018, the lowest print in the last eighteen months. While 5 Food items were in deflation in December 2018 and Fuel also softened, excluding these two i.e. Core Inflation remained thereabouts at 5.6% in Dec-18 vs. 6.2% in Oct-18. The RBI reiterated that it would stick to its mandate of headline inflation targeting instead of core.

    • CPI Trajectories (% yoy)

      Source: MPC Policy Statements, Jun-19

      • Inflation expectations of households’ survey:

        Source: MPC Policy Statements, Jun-19

        • MPC forward estimates of CPI: Continued food deflation rooting from excess domestic and international supply among all food groups warrants a benign food inflation outlook. Fuel consumption moderated unexpectedly, inflation falling from 8.5% to 4.5% in December. Softer crude oil prices and supply cuts broadly indicate weaker Crude. Effects of HRA increase have dissipated and household inflation expectations have moderated significantly.

          • Liquidity update: The liquidity needs arising out of expansion in currency were met by the RBI through injection of durable liquidity amounting to INR 500 billion each in December and January through OMOs. Accordingly, total durable liquidity injected through OMOs has aggregated INR 2.36 trillion during 2018-19 so far. Liquidity injected under the LAF was INR 996 billion in December on an average daily net basis, and INR 329 billion in January. In February, however, the average daily liquidity position turned into surplus with an average absorption of INR 279 billion.

            • Market Reactions:


              While headline CPI has more than played its part of remaining well-behaved, the Core remains a spot of bother and the ongoing rural weakness on the macro economic growth front from the Farm income Support program should keep further yield softening in check.

              Hence, avoid long duration funds.

              Ahead of the General Elections, increased currency in circulation (related to spending activities etc.) could likely keep rates at the short end elevated. Today’s rate cut has spurred some relief rally on the short end of the curve and yields declined here. The long end of the curve on the other hand, could continue to face a supply-demand equation issue as the Interim Budget highlighted sustained levels of borrowing at the Centre, the GOI announced additional borrowing of INR 36,000 Cr. in the last couple of days for FY19 and the borrowing calendar has been extended to March from February. So, a steepening of the yield curve can be expected. Nevertheless, prefer good quality Low duration Funds and Ultra Short-Term Funds.

              Market Borrowings on the Rise though Fiscal Deficit Stable

              Source: CMIE. Data for 2019-20 are Budget Estimates (RE), Data for 2018-19 are Revised Estimates (RE)

              On the corporate front, the RBI has now allowed worthy NBFCs of raising funds from banks with their risk exposures now linked to their (NBFCs’) credit rating. This has aligned the rating exposure mechanism to those of other debt-raising corporates and places a greater onus on credit rating agencies to maintain stricter credit assessment techniques. This could keep the corporate yield curve firm as well. Given the prevailing risk-reward trade-off, we continue to prefer high quality short duration funds and corporate bond funds over credit risk funds.


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