RBI maintains status quo in monetary policy

Indian Economic Update

India: Growth poised for recovery in H2 FY2018

GDP growth for Q2 FY2018 came in at 6.3% YoY with GVA at 6.1% YoY (our expectation 6.2% YoY). This was a welcome development after growth remaining stagnant for two consecutive quarters.


Key highlights of Q2 FY2018 GDP:

  • What is even more encouraging is the fact that non-agriculture non-government spending growth rate has accelerated significantly to 6.8% YoY in Q2 as compared to 5.5% YoY in the previous quarter and the low of 3.8% YoY in March 2017. In fact the Q2 growth rate is now at similar levels as September 2016 (i.e. the period before one-off shocks such as demonetisation and GST were administered).
  • Agriculture growth remained weak as food grain production declined in the Kharif season as compared to robust growth last fiscal. For the entire year agriculture is unlikely to provide any significant support in light of bumper harvests seen last year.
  • Industry growth picked up strongly to 5.8% YoY from 1.6% YoY earlier aided by a robust improvement in manufacturing activity (7% YoY vs. 1.2% YoY previous quarter). IIP growth has shown substantial improvement over the quarter and lead indicators for the same continue to remain fairly robust. However, even though there seems to be a manufacturing recovery (most of which would also be on account of GST restocking), there is no such discernible recovery in exports growth which still remains muted (1.2% YoY in Q2 FY2018).
  • Services growth was slower than what we had expected mainly pulled down by much slower government spending which may continue over the next two quarters as well as the fiscal situation remains under stress. Government revenue spending net of interest payments and subsidies grew by a meagre 0.8% YoY in Q2 FY2018 as compared to 20.8% YoY in the same period last fiscal.
  • Moreover, services sector growth especially for a component such as trade, hotels, transport etc. is proxied by sales tax collections. In the post GST regime, this approximation has become model based as sales tax collections for Q2 would have to be inferred in absence of comparable data till such time that GST issues are sorted out. Hence, it is possible that this sector’s output could see significant revisions in subsequent quarters.
  • We draw comfort from the fact that private consumption growth has not declined substantially from the levels seen in the previous quarter as was our fear. Real growth remained almost steady at 6.5% YoY as against 6.7% YoY in the previous quarter. However, we still maintain that if this growth rate is to sustain then enduring support from manufacturing and investments would be required over the medium term.
  • Gross fixed capital formation has started to show a slight uptick and printed 4.7% YoY which is the highest growth rate registered in a year. We could see some nascent pick up in this sector but meaningful recovery is still probably a while away in the face of widespread corporate deleveraging.
  • On balance there could be slight downside risks to our full year estimate and we now expect FY2018 GVA could be ~6.5% YoY as against 6.6% YoY earlier. With this we would peg our indicative FY2019 GVA at ~7.3-7.4% YoY. Risk factors which bear watching for the rest of this fiscal are any further statistical measurement issues on account of tax rationalisation, increasing crude oil prices and the possibility of much lower government spending on fiscal constraints.

Overall, we expect GDP growth to remain on an uptrend in H2 FY2018 supported by fading of GST-related disruptions, renewed build-up of supply chains, improved consumption demand and better export performance. In this context, the uptick in non-agri non-government GVA (core GVA) is a very welcome development, as fiscal concerns may keep government spending muted.


RBI: Monetary policy likely to remain on pause in foreseeable future

Following a balanced deliberation, the RBI maintained status quo in the policy meeting. The central bank left the repo rate, reverse repo rate and MSF rate unchanged at 6.0%, 5.75% and 6.25% respectively. The outcome was broadly in line with market expectation and five out of the MPC’s six members voted for the decision.


Key takeaways from the policy statement:

Growth:The outlook on growth was slightly positive given the fact that RBI retained the GVA growth projection at 6.7% for FY 2018 despite weaker first half growth. This is slightly higher than our expectation of 6.5% growth for FY 2018. The central bank believes that, recapitalisation of public sector banks, capital raising in the primary markets, improvement in the ease of doing business and initiation of the asset resolution mechanism through the insolvency and bankruptcy code route are expected to support growth.

Inflation: Inflation projection was nudged slightly higher at 4.3-4.7% in Q3 and Q4, including the HRA effect of up to 35 basis points. The central bank expects the reversal in core inflation trend to persist, the staggered impact of various state government HRA hikes to push housing inflation further in 2018, increase in international crude prices and any spill over from geopolitical tension has the potential to push inflation higher. Offsetting factors such as seasonal moderation in vegetable prices, downward bias in pulse prices and lowering of GST rates for several goods and services are expected to limit the rise in headline inflation.

Excess liquidity: From a significant surplus, domestic liquidity has continued to decline on the back of currency leakage, open market sales and MSS. In the post policy conference, RBI noted that they expect system liquidity to be neutral by H1 FY2019. The clarity provided on RBI’s liquidity operations is welcome and it seems OMO actions would be undertaken as a response to FX flows. Having said that it seems unlikely that any OMO purchases are on the cards given that RBI’s forward book and the outstanding MSS are due for maturity as well.


Inflation and fiscal concerns to weigh on bond yields

From a fixed income market perspective, we believe that the evolving fiscal situation is likely to be a crucial driver for bond yields going forward. Further the higher CPI inflation reading for November is also expected to weigh on the bond market. However, the balanced policy statement has alleviated the concern regarding the scope of any near term policy tightening and we believe that market expectation will shift to prolonged pause in the foreseeable future. This is expected to support the short end of the yield curve and we believe that steepness in the yield curve is expected to persist.


Development and regulatory measures:

  • Improvement in Monetary Policy Transmission: Given the limitation of the base rate/ MCLR regime in effective transmission, a switchover to an external benchmark in a time-bound manner is being considered.
  • Allowing Overseas Branches/ Subsidiaries of Indian Banks to Refinance ECBs: Permit the overseas branches/ subsidiaries of Indian banks to refinance ECBs of AAA rated corporates as well as Navratna and Maharatna PSUs, by raising fresh ECBs.
  • Report of the Working Group on Hedging of Commodity Price Risk by Residents: The major recommendations of the Group include the creation of a ‘Positive List’ of commodities that can be hedged and enabling inventory hedging, price fix hedging as well as hedging of the currency risk resulting from overseas commodity derivatives. The Reserve Bank shall examine the Group’s recommendations and the public feedback.


Other important developments during the week:

  • India manufacturing PMI rose to a 13-month high of 52.6 in November from October's 50.3.
  • The Nikkei India Services PMI Business Activity Index declined to 48.5 in November from 51.7 in October.

Global Update

Important developments during the week:

  • The Senate passed the “Tax Cuts and Jobs Act,” a massive overhaul of the tax code by a margin of 51-49, bringing Republicans closer to delivering on President, Mr. Donald Trump’s tax cut promise.
  • European Commission President, Mr. Jean-Claude Juncker and British Prime Minister, Ms. Theresa May failed to reach an agreement on Brexit deal during their meet in Brussels.
  • In line with expectations, Reserve Bank of Australia (RBA)’s board decided to keep the Cash Rate target unchanged. Notably, the statement dropped reference to its expectations of inflation staying low for “some time”.
  • In a significant political development, US President, Mr. Donald Trump announced that they would officially recognise Jerusalem as the capital of Israel. President, Mr. Trump added that the announcement would mark the beginning of a new strategy for brokering peace between Israel and Palestine.
  • Bank of Canada maintained interest rates steady at 1.0%. While suggesting that higher rates will likely be needed over time, the statement emphasised the need to “continue to be cautious” on the interest rate front. Overall, the statement was less hawkish than expected.
  • In line with market expectations, Central bank of Brazil cut its benchmark Selic rate by 50bps to 7.0%. Policymakers also signalled a further reduction at the next meeting and said that the inflation trend was favourable.


Indian equities started the week higher, snapping a four session losing streak.  The gains in domestic equities come despite the losses in Asian equity peers. Market remained cautious ahead of the RBI’s monetary policy during first half of the week.
Equities were trading lower following cues from Asian equity markets. Global equities continued a free fall over the past few sessions as valuations look expensive. Further, RBI’s monetary policy, which while maintaining neutral stance increased its inflation forecast marginally, weighed on bank stocks.
Meanwhile, equity indices gained. Renewed buying by institutional investors and a surge in global equity markets propelled the Nifty sharply above the 10,100-mark. Investors also resorted to value-buying after a fall.


During the week Sensex gained 1.27% to close at 33250.3 while Nifty advanced 1.40% to close at 10265.65.


Indian Bonds started lower, the yield of the benchmark bond touched a high of 7.10 during the day. Rising crude oil prices, the threat of fiscal slippage and rising inflation were putting pressure on domestic bonds. Traders also remained cautious ahead of the RBI’s bi-monthly policy. Markets took some comfort from RBI’s post policy press conference, wherein officials didn’t hint at any imminent rate hike.


The optimism surrounding RBI’s monetary policy faded away, as gilts were subject to continued selling pressure. Markets now await a slew of data releases including US NFP data, Fed’s policy decision and India CPI print for November. The overall market sentiment continues to be weighed down by high oil prices, risks of government’s fiscal slippage and surge in inflation over past few months.


The 10Y benchmark yield ended at 7.09% as compared to the previous week’s close of 7.06%.


Oil started week lower as investors booked profits after the much anticipated production cut extension led by OPEC last Thursday. The Saudi energy minister reaffirmed that OPEC would not alter its course even if something unexpected takes place. Contrary to the efforts of OPEC and 10 other nations to balance oil markets, US output is seen as a major threat, as oil drillers increased their rig count by 2 last weeks to take the total count to its highest since September. Traders suspect that OPEC’s deal to extend production cutbacks may take U.S. shale activity to a whole new level.
The perception that the higher fuel stocks pointed to weak demand outweighed the drop in crude inventories by 5.5 million barrels to 451.8 million barrels, as gasoline stocks rose by 9.2 million barrel last week. Investors seemed to be closing their positions and booking profits from the impressive rally over the past few weeks, after an unexpectedly large rally in US stocks of refined products released by EIA.


Gold traded lower during beginning of the week as the dollar gained on expectations that the United States’ economy will expand further after the Senate passed a bill to overhaul the country’s tax system. Physical gold demand was steady in most Asian centers as buyers hoped for further price dips amid growing appetite for riskier investments. Some bearishness can be attributed to a fall in holdings by SPDR Gold Trust, the world's largest gold-backed exchange-traded fund.


Gold broke its strong support level of USD 1260/oz towards the end of the week as the dollar inched up against its peers, as optimism over US lawmakers making progress on tax legislation continued to grow.


Indian Rupee started week higher. Rupee pared some early day gains as public sector banks resorted to heavy dollar purchases. Marginal decline in the dollar index aided the domestic currency. However, dollar purchases by PSU banks pared rupee’s further appreciation.
The weakness in the domestic equity markets weighed on the rupee. However, with the RBI increasing its inflation forecast, the probability of rate cut has been almost entirely ruled out, supporting rupee in the medium term.
Further, foreign banks resorted to heavy dollar purchases. Exporters’ dollar sales and positive performance of equity markets curtailed further depreciation of the rupee towards the end of the week.


Source: ICICI Bank Research, Bloomberg and CRISIL.