RBI: MPC maintains status quo

Indian Economic Update

RBI: MPC maintains status quo; growth outlook downgraded
Reserve Bank of India (RBI) left the policy rate unchanged in the meeting broadly in line with market expectation. Post the decision, the repo rate, reverse repo rate and the Marginal Standing Facility (MSF) rate stay unchanged at 6.00%, 5.75%, and 6.25% respectively. The Monetary Policy Committee (MPC) voted 5-1 to keep rates unchanged, with one-member voting for at least 25 bps rate cut.
The RBI also cut the Statutory Liquidity Ratio (SLR) by 50 basis points from 20.0 percent to 19.50% of banks’ Net Demand and Time Liabilities (NDTL) from the fortnight commencing October 14, 2017. The ceiling on SLR securities under ‘Held to Maturity’ (HTM) was also cut from 20.25 per cent to 19.50 % of banks’ NDTL but in a phased manner (20% by December 31, 2017 and 19.50% by March 31, 2018).


Key takeaways from the policy
Growth: RBI lowered the growth projections from 7.3% earlier to 6.7% in FY 2018 amid loss in momentum in Q1 and lower than expected advance estimate of kharif production. In the post policy conference, RBI noted that the ongoing deleveraging process is weighing on growth from a medium term perspective.
Even though the RBI has revised the growth forecast lower, the central bank expects the growth outlook to improve going forward. The GST problem is likely to be short-lived and household consumption is expected to receive support from states’ pay commission implementation.
The ongoing structural reforms taken by the government in the recent periods are growth supportive in the medium term by improving the business environment, enhance transparency and increase formalisation of the economy. Further, the global condition is also benign, amid improving growth and trade prospects.
Inflation: RBI has revised the inflation forecast for the second half of FY 2018 to 4.2%-4.6% from the previous expectation of 4.0%-4.5%. The rise in projection comes against the backdrop of rising core inflation, uptrend in crude prices globally and some GST related price revisions. The MPC highlighted the implementation of the farm loan waiver by states and the introduction of pay commission by states as key sources of upside risks to inflation. State pay commissions are expected to add ~100 bps to the base line inflation over a period of 18-24 months. The escalation in global geopolitical uncertainty and heightened volatility in financial markets due to unwinding by US Fed and normalisation by the ECB were also cited as concerns.


Further policy easing to be data dependent
While the argument for further rate cut is still valid, the possibility of the same has reduced considerably post meeting. RBI maintaining the neutral stance and reiterated the need to keep headline close to 4% on a durable basis suggests that undershooting of the latest inflation projection is crucial for further action. In this regard, the recent disinflationary trend in food prices especially vegetables, is the crucial variable to watch out for. The commentary on growth seems to be fairly positive even while considering the deleveraging of the impaired balance sheet of corporate India, which might be revisited at a later date. We will watch evolving data prints to determine the possibility of further action, but at the moment space seems limited.


Bond yields to trade ranged with an upward bias
From a fixed income market perspective, besides the reduced possibility of a rate cut, we believe that the evolving fiscal situation is likely to be another crucial driver for bond yields going forward. Considering the impact of excise duty cuts and the lower dividend from RBI adds at least ~30 bps to the Centre’s fiscal deficit target of 3.2%.
Additional risks with regards to GST related uncertainty on tax revenue growth, missing targets on disinvestment and spectrum payments etc. are also expected to weigh on bond market trajectory in the medium term. Additionally, the measures announced by the RBI regarding the phased reduction in SLR and HTM limits and the introduction of weekly SDL auctions are also bond negative steps.


Other important developments during the week:

  • Manufacturing activity stood unchanged in September, with PMI recording a print of 51.2, similar to level seen during the previous month.
  • Eight core infrastructure industries showed a marked improvement, growing by 4.9% YoY in August vs. 2.4% YoY during the prior month.
  • India services PMI bounced back to expansion in September, registering as print of 50.7. The reading marked a sharp improvement over previous month’s 47.9 (indicating a contraction in activity).
  • Unconfirmed media reports suggest that Finance Minister, Mr. Arun Jaitley is likely to tender his resignation citing health reasons.
  • Media reports suggested that there might be a decision on drastic reduction in GST levied on a majority of goods and services. The announcement might come at the end of the GST council meet.



Global Update

Important developments during the week:

  • Reserve Bank of Australia (RBA) left its benchmark interest rate on hold at a record-low 1.5% as expected in its October monetary policy, balancing concerns around high household debt and weak wages growth with signs of a stronger job market.
  • Spain faced one of biggest constitutional crisis in decades after Sunday’s independence referendum in Catalonia, which the Spanish government under Mr. Rajoy is unwilling to accept.
  • Oil and gas platforms are being shut down in the Gulf of Mexico as Tropical Storm Nate approaches.
  • The minutes of the European Central Bank’s September 6-7 policy revealed that policymakers started their debate about next year’s monetary stimulus by focusing on how to balance the size and duration of monthly asset purchases. The Governing Council looked at “general trade-offs” between various scenarios for bond buying. They also reiterated that they intend to move extremely carefully to avoid surprising investors. There was “broad agreement” that substantial support was still needed to ensure inflation returns to target.




Indian equities started the week higher following cues from Asian peers. On the domestic front, investors are hopeful of a growth rebound consequent upon the Government’s proposed fiscal stimulus. RBI's projection of acceleration in growth in the second half of the current financial year also supported the sentiments.
Meanwhile, with the RBI keeping interest rates steady and suggesting that margins of corporates may remain weak due to rising input costs and disruptions due to transition to a new tax regime, markets do not expect a recovery in earnings in the near term.


During the week Sensex gained 1.70% to close at 31814.22 while Nifty inclined 1.91% to close at 9979.7.





Indian Government bonds started the week higher. Gilts traded in a narrow range ahead of the outcome of RBI's policy during beginning of the week. Short covering along with value buying after the sharp fall in prices on last Friday supported bonds. However, RBI's Open Market Operations (OMO) sale announcement weighed on sentiment.
Meanwhile, RBI revising its inflation projections marginally upwards was seen as a major negative for future rate cut prospects. Further, the MPC highlighting risks to inflations emanating from probable fiscal slippage has also put the gilts under pressure.  Traders continued to trim their holdings as rate cut hopes fell after RBI increased the inflation forecast for H2 FY2018. Traders also refrained from taking fresh positions ahead of the release of state government borrowing calendar for October - December 2017.


The 10Y benchmark yield ended at 6.74% vs. previous week’s close of 6.66%.




Oil prices started this week lower. Crude prices eased as speculators liquidated some large long positions built up in the last couple of weeks, but the prospect of rebalancing in the oil market lent some support. Meanwhile Baker Hughes reported a rise in the oil rigs, for the first time in four weeks.
Crude prices continued to decline. The market ignored the API data, which indicated a draw of 4.1 million barrels. Recent surveys indicated an increase in OPEC output for September, bringing down its compliance levels in comparison to August. 




Gold started the week flat at USD 1271/oz, after dropping to its lowest levels in seven weeks. The yellow metal was subdued after the release of strong US economic data, further reinforcing the likelihood of a rate cut by Fed this December.
Meanwhile, the yellow metal was buoyed by a retreating dollar, which eased from a one-and-a-half-month high.




Indian Rupee started sharply weaker. Rupee weakened on account of dollar purchases by foreign banks. Dollar index strengthened as Fed’s December rate hike probability increases is weighing on emerging market currencies.
Rupee gained sharply during mid-week as heavy dollar sales by foreign banks after RBI policy outcome triggered stop-losses at multiple levels. Further, exporters' dollar sales also supported the domestic currency.
However, heavy dollar purchases by public sector banks triggered stop losses. Further, the mild strengthening of the dollar index also weighed on the domestic currency towards the end of the week.


Source: ICICI Bank Research, Bloomberg and CRISIL.