On December 6, 2017, the Monetary Policy Committee of the Reserve Bank of India will be announcing the monetary policy stance with the actions being taken on the policy stance, governance and other statutory measures announcements to handle the various crucial indicators of the economy. In this blog, I shall focus on the 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:
- Repo Rate – 6%
- Reverse Repo – 5.75%
- Marginal Standing Facility – 6.25 % (Being pegged at 25 bps to the repo rate)
We will take a look at the various factors that will be considered in the following broad areas:
- Macro economic outlook (Inflation Included)
- Price Vs Cost Analysis
- Demand & Output
- Financial Markets & Liquidity Conditions
- External Environment
Macro Economic Outlook:
From the review reports of the RBI, the inflation and growth in Gross Value Added (GVA) projections have been deviating from the baselines set in April 2017. However, the global macro-economic and financial conditions has been in-lines with the projections by the RBI at the beginning of the FY 2017-18.
The deviations in the inflation and GVA growth projections can be explained in the following aspects:
- Uneven and deficient rainfall in some parts of the country has negatively impacted the kharif output.
- Global Crude prices have moved in a relatively wide range of $44-$57 and are expected to average to $55/barrel in the second half of the FY 2017-18 which might push inflation northwards
- Weak global trade and growth barring the emerging economies. Advanced Economies are expected to show further weakness with the US fiscal being significantly less expansionary
Price Vs Cost Analysis:
Consumer price inflation fell sharply in the first quarter of 2017-18, driven down by a collapse in food inflation and a marked moderation in inflation in other components. The trajectory reversed in July and August as vegetable prices spiked and prices of other goods and services firmed up. Input costs tracked movements in international
commodity prices, while wage growth in the organised and rural sectors firmed up modestly.
- The declined food prices during the first half will start to reverse amidst typical seasonal price firming
- Significant increase in the HRA allowance by the Central Government shall add to inflationary increase
- Broad rebound in the underlying inflationary measures in the previous quarter
- Inflation expectations will play a key role in shaping the actual outcome
- PMI indicates that the manufacturing as well as the services sector are facing input & output price pressures thus leading to contracted growth trends
- Professional forecasters surveyed by the Reserve Bank in September 2017 expected CPI infl ation to pick up to 4.5 per cent by Q4:2017-18, reflecting the combined effects of unfavourable base effects, the upturn in food prices
and the impact of the increase in the HRA
Demand & Output:
- Aggregate demand has been impacted by slowing consumption demand, still subdued investment and a slump in export performance in the early months of 2017-18.
- Manufacturing activity, which was dragged down by one-off effects of the implementation of GST, weighed heavily on aggregate supply conditions.
- Notwithstanding initial deceleration, agricultural prospects remain stable and acceleration in services sector activity could impart resilience to the overall supply situation in the rest of 2017-18.
- While the Govt awaits for GVA demand and growth data for the 2017-18 Q2, following is the current status as per the data up to Jul 2017:
Financial Markets & Liquidity Conditions:
Financial market conditions in the first half of 2017-18 remained stable, with the weighted average call money rate (WACR) moving progressively closer to the policy repo rate, stock markets scaling new highs, bond yields oscillating with fluctuations in inflation readings and the foreign exchange market buoyed by large portfolio flows. Credit off-take from risk-averse banks remained low, though monetary policy transmission strengthened for new loans in conditions of sizable surplus liquidity.
Following are the key aspects that would be considered by the RBI:
- Equity markets scaled new peaks relative to earnings, propelled by a renewed reach for returns
- The US dollar depreciated against major currencies, partly correcting for the upside it had gained post-Presidential elections in the US
- Corporate bond yields softened, tracking, G-sec yields and moderation in credit spreads
- Deposit rates have declined as banks were flush with liquidity
- Credit flows from banks improved modestly, though still hamstrung by stressed assets induced deleveraging and weak investment demand
- A cumulative 200 basis points (bps) cut in the repo rate since January 2015
has been, by and large, transmitted to lending rates on new loans; however, transmission to past loans remains incomplete
With the inflation inching upwards and expected to move northwards thus increasing the average inflation, significantly weak demand and lower manufacturing & services sector growth, the MPC would would closely watch the inflation numbers and the CSO growth forecast metrics to be released in the near future
I predict, that the RBI will maintain the status quo in order to contain the increased expected inflation, lower growth rates and credit demand. CRR will be untouched due to the ample amount of liquidity. It is likely that the MPC might decide to cut the SLR rates to 19% from the current levels of 19.5% in order to support the liquidity effectively.
However, the forward guidance of the policy will be focused on cleaning up of the balance sheets and insolvency. The Indian Economy will have to have to wait to for at least 2 more bi-monthly reviews to see any expansionary stance in their policies due to inflationary fears.