Sixth Monetary Policy Committee Meeting

The sixth meeting of the Monetary Policy Committee (MPC), will be held on August 2 and 3, 2017 at the Reserve Bank of India. The MPC shall review the surveys conducted by the Reserve Bank to gauge consumer confidence, households‟ inflation expectations, corporate sector performance, credit conditions, the outlook for the industrial, services and infrastructure sectors, and the projections of professional forecasters. The Committee shall also review in detail staff‟s macroeconomic projections, and alternative scenarios around various risks to the outlook. The decision of the MPC shall be in accordance with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. In this blog, I shall focus on the above mentioned parameters to access the likely policy action to be taken by the RBI in their monetary policy review scheduled next week.

The current scenario of the policy rates is as follows:

  1. Repo Rate – 6.25%
  2. Reverse Repo – 6%
  3. Marginal Standing Facility – 6.50 % (Being pegged at 25 bps to the repo rate from the last policy review since the volatility of the call rates has significantly reduced)

GLOBAL ECONOMIC OUTLOOK:

The global economic activity has been growing at a modest pace, catalyzed by the emerging economies and some of the advanced economies. US markets have benefited from the wage gain and the industrial production has been steadily improving. However, US continues to face ebbed sales figures at home. The Euro zone continues to struggle in their movement towards growth. The political risk continues. Japan seems to be struggling with the subdued domestic demand and the political instability concerning the removal of Abby. Among the emerging economies, China has shown significant signs of stability, Russia has been witnessing improved recovery in their macro fundamentals while South Africa continues to face the depressing economic conditions. This clearly indicates that the global economic activity has been fairly slowed down and is expected to stay so for the coming 2 quarters as most of the emerging and advanced economies struggle to provide growth impetus.

The air freight and the container throughput have shown increasing trends indicative of strengthening global demand. Crude prices fell to a five month low in early May on higher output from Canada and the US, and remain soft, undermining the OPEC‟s recent efforts to tighten the market by trimming supply. These developments suggest that the inflation outlook is still relatively benign for AEs and EMEs alike.

GLOBAL MONETARY POLICY STANCE:

Since late June central banks of developed markets have suddenly started echoing calls for a sooner-than-anticipated normalization of policy on the back of solid growth despite sluggish inflation.

After Fed’s 25bps of rate hike in June, Bank of Canada has already followed by hiking the policy rate by 25bps, the first hike in 7 years. Meanwhile ECB and BoE, although for different reasons, have also been sounding hawkish. The coordinated policy statements led to a sharp reversal in sentiments, resulting in bear steepening of the yield curves across US and Europe. Japan remains the odd one out, given BoJ’s recent fixed rate bond intervention in order to reinforce its commitment towards massive monetary accommodation. However, lately we have witnessed some reversal in earlier tight rhetoric from Fed members, lack of hawkishness in Fed Chair Janet Yellen’s testimony and some ECB members playing down earlier hawkish comments by ECB’s Mario Draghi.

INFLATION OUTLOOK:

On the domestic front, the recent CPI inflation print of 1.54 per cent is significantly lower than RBI’s already downward revised range of 2-3.5 per cent for first half of FY2018. With another print expected to be a tad below 2 per cent (despite inclusion of 7CPC HRA component), and the sustenance of low food inflation in the pre-monsoon summer months is expected to provide comfort to RBI that at least part of the food disinflation is structural in nature.

The forecast of a favourable monsoon further bodes well for food inflation. Also, the refined core index – core excluding petrol, diesel, gold and silver – a metrics of real underlying price pressures, continues to inch lower, suggesting a slower narrowing of output gap than probably anticipated by RBI.  Overall, given the not-so-adverse global environment and benign inflation trajectory, it will be very difficult for RBI to provide a rationale for not easing in the upcoming policy. The headline inflation is likely to stay at sub-4 per cent till November 2017. Undoubtedly, the June inflation reading marks the trough and we thereafter expect a gradual uptrend through rest of the year. In 2HFY18, inflation may largely range between 3.3-4.5 percentage, mostly in line with MPC’s projections.

GROWTH OUTLOOK:

On the growth front, Index of Industrial Production has shown clear signs of stagnancy so far at 1.7% and the central bank has forecasted that the IIP index may further slow down in the next 2 quarters. Also, the Q1 earnings of most companies have not been satisfactory as compared to the inflated valuations of the markets lately. With IIP slowing down, it might act as a key parameter in deciding the policy actions this time.

BANKING SECTOR:

The banking sector has been facing turmoil because of the rising NPA’s and reduction in the overall increase in the exposures. The public sector banks have seen a sluggish credit growth of 7.26% whereas the private sector banks are clocking a fairly good credit growth rate of 17%. This trend is not new for India although, the public sector lenders have been defensive lately due to increasing bad loans. However, RBI might take some new actions in terms of forcing the public sector lenders to create sophisticated systems in order to perform an efficient credit and risk management and simultaneously clean up the balance sheets. With the probability to reduce interest rates in August 2017, the lingering fear of banks shifting their focus to credit growth from balance sheet clean ups shall continue to persist.

With the average inflation almost close to the comfortable levels of 3%, sluggish demand and higher industrial growth, RBI and the MPC would would closely watch the inflation trends in the near future. However, certain additional structural reforms in order to help banks clean up their NPA loaded balance sheets can be expected.  

I predict, that the RBI will cut the repo rates by 25 bps to 6% from the current rate of 6.25% in order to foster growth, IIP and the sentiments. CRR and SLR will be untouched due to the ample amount of liquidity and money supply in the system. The RBI would also like to ensure that the economy’s ERI  of 1% at least which is currently higher at 1.75%.

However, the forward guidance of the policy will continue to be fairly dovish, reform-driven and a certain push towards a more efficient monetary policy transformation. Although, the MPC will have to ensure that the rate cut does not impact negatively on the ongoing balance sheet clean ups and insolvency declarations with an expansionary policy action this month.

Counters are welcome. Thank you 🙂

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One Nation, One Tax- Yay or Nay?

The NDA Govt – as part of the most prominent reform since Independence – rolled out the much awaited Goods & Services Tax reforms on the 1st of July, 2017. In this blog, we will understand why GST could not be the uniform tax NDA Govt was aiming for, we will also access the impact of the GST, how will it affect your pocket, the likely challenges the assesses will face while filing the GST taxes which is termed as “The Tax Maze” and ultimately what stocks should you look out for to plan your personal investment decisions.

What was the current problem Indian economy was facing? For consumers, India’s GST is one tax in the most practical sense that currently a bar of soap costs, theoretically, 29 different prices across 29 different states due to 29 different state VATs. Under the GST regime, there’s just one GST rate for a bar of soap. Where India differs from other countries that have implemented GST is that there isn’t one single rate that applies to all goods or services. For example, in Singapore, the tax levied on a pair of shoes and the tax levied on a bar of soap is the same – 7%.

Here’s a quick comparison of rate structure in India as compared to a few selected countries who have successfully implemented GST earlier.

Country Tax Rate
India 5%, 12%, 18%, 28%
Singapore 7%
Malaysia 6%
New Zealand 15%
Aruba 1.5%
Brazil 7%, 12%
Germany 19%

However, the one nation one tax regime was not quiet achieved as the NDA Govt had to factor in the fact that the poor were to be protected from the high rates & a set of political considerations which includes vote bank. In India, the GST council has come out with a rather unwieldy four-rate structure: 5%, 12%, 18% and 28%. In addition to this, there is the exempt category (0%) and additional cesses that are charged on top of certain products, which makes our GST regime have seven effective tax rate slabs.

What will be the macroeconomic impact of the GST rate structure?

 

The impact of GST was anticipated to provide an increase in the GDP growth rate by close to 2-3% provided the GST tax structure was comprehensive. However, witnessing a significantly complicated structure as ours, I suspect that the the GDP growth would not be more than 0.5-1% as compared to the current growth rates. The reason being the complexity of multiple tax rates and continuation of the various exemptions.

A recent analysis by HSBC shows that the roll out of GST is likely to add only 0.4% to GDP, “lower than earlier estimates as multiple tax rates and exemptions announced… are far from an ideal structure and could blunt the growth impact of the reform process.”

Sectoral Impact?

The GST benefit to a certain sector depends on the following two factors:

  1. The actual rate of taxation
  2. The extent to which the operating costs of a particular sector are eligible for the input credit

If a particular sector has higher tax rates but has significant amount of the input credits, the sector shall actually reap the benefits of lower operating costs.

Following is quick synopsis of the critical sectors and the likely impacts:
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Filings Maze!

Businesses will have to undertake 37 annual filings (three a month plus an annual return) for each state the firm operates in. The basic problems for most small and informal businesses are similar: operating costs are about to go up as business owners hire accountants and computerise their operations. Anecdotal reports show that small firms with revenues of below Rs 1 crore could have 20% to 40% of their existing profits go towards GST compliance costs and higher tax rates. Thus, the overall operational costs might push the overall profitability southwards in the medium term. However, once the processes are streamlined, the growth rates might increase but the improvement comes with a significant gestation period.

Joblessness?

GST is deemed to be a bridge to convert the unorganized sector into an organized form. However, it’s largely unclear at this point what extent of small businesses will simply become unviable post-GST. A recent report is not optimistic on what the new GST regime will do for job creation. We note that unorganised sector employs a majority of the labour force. With the unorganised sector shifting to the organised sector, a significant labour absorption capacity that currently exists may get eroded. This can compound the already chronic problem of job creation in India.

Markets Trajectory?

The stock markets have advanced significantly and have taken a positive cue from the fairly smooth roll out of the GST reforms. There were 2 advancing stocks for each decline in the markets for the week so far. However, the markets are expected to be jittery in the medium term as the turmoil regarding the GST filings and the infrastructure glitches.

The markets are expected to drop to the 9400 levels due to corrections. However, the technical indicators of Fibonacci extensions suggest that if the Nifty crosses the 9706 mark, the markets will turn bullish in the medium term. The data currently suggests that the markets are overpriced. Here are my picks for a medium term investment goal to watch out for on corrections:

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What does it mean for YOU as a consumer?

  • Day-to-day essentials are largely exempt from GST
  • Banking and telecom services will get more expensive
  • Eating out to be cheaper if you eat at a non-air conditioned restaurant
  • Luxury cars, which will get cheaper
  • Movie tickets, especially regional cinemas, will get more expensive
  • FMCG products will be cheaper

Anti-profiteering

For instance, soaps and toothpaste are supposed to get cheaper after the rollout of GST. They currently have an effective tax rate of 24-25% and after GST, this will come down to 18%. However, if as a consumer, you have always been paying say Rs 75 for a tube of toothpaste, it’s highly unlikely that the company that sells you the toothpaste or bar of soap will make it cheaper once you’ve gotten used to paying Rs 75.

To solve this potential problem, the GST legal framework creates an “anti-profiteering authority” that will check whether businesses are passing on the benefits of the new tax regime to consumers. Legal experts and industry leaders have almost unanimously declared that this anti-profiteering body will spark a minefield of litigation and prove to be problematic.

Conclusion

GST roll out on time and with ‘just enough’ infrastructure is a bold move by the NDA Govt. I do agree with the fact that the awareness approach could have been better. On a consolidated basis, the end consumer may not be the most benefiting entity in the economy. The businesses will be definitely benefited from the GST structure. However, there are a few aspects where the NDA Govt must act in the coming years. Once stabilized, the NDA Govt must try and unify the existing 4 rates as the economy starts witnessing the long term benefits of the GST regime.

Thank you. 🙂

Opinions and counters are encouraged!