The MPC cut the repo rate by 35 bps to 5.40%, while maintaining stance of policy as accommodative. The move to cut was unanimous with the 35 bps to 25 bps vote counting as 4:2. It may be recalled that Governor Das had earlier floated the idea of challenging the conventional 25 bps moves, with unconventional steps like the one today possibly reaffirming the signaling effect of policy direction as well. The major forecast changes are summarized in table below:
Source: RBI. Note: For CPI, H1 FY20 number in August 2019 and both FY20 numbers are calculated
Furthermore, additional steps were undertaken to incentivize credit flow to the NBFC sector:
1. Raise a bank’s exposure limit to a single NBFC to 20% of Tier-I capital of the bank (from 15%), in line with existing limit for entities in the other sectors.
2. Allow, subject to certain conditions, bank lending to registered NBFCs (other than MFIs) for on-lending to Agriculture (investment credit) up to Rs. 10 lakhs, Micro & Small Enterprises up to Rs. 20 lakhs and housing up to Rs. 20 lakhs per borrower (from Rs. 10 lakhs) to be classified as priority sector lending. This is targeted to further increase credit flow to certain priority sectors, given the important role played by NBFCs.
3. Reduce risk weight for consumer credit (including personal loans but excluding credit card receivables) to 100% from 125% or higher (latter if warranted by the external rating of the counterparty).
Assessment
The policy is largely in line with the dovish end of expectations. There is no decision with respect to the working group on liquidity management framework. However, the Governor did note the very large surpluses in the system today and reaffirmed the commitment to provide abundant liquidity. Thus the implementation basis the recommendations of the framework is very likely to be consistent with the current market view that RBI has already moved to targeting surplus liquidity. He remained ambivalent on the other important issue of offshore sovereign bonds maintaining that the RBI had provided its views to the government. Apart from this, there are two stand outs in the policy as follows:
1. Inflation: The RBI’s assessment is for CPI to remain comfortably below 4% for the full current forecast horizon. Additionally, this is backed by a muted assessment of the more durable factors, rather than food and fuel. Thus in particular the softness in core inflation is assessed to be broad based across clothing and footwear, household goods and services, transport and communication, and recreation and amusement. Further, households’ inflation expectations are unchanged in the July 2019 round for 3 months ahead versus the previous round; whereas expectations have moderated a further 20 bps for the 1 year ahead horizon. Input cost pressures have continued to ease, nominal rural wage growth has remained muted, while growth in manufacturing sector staff costs eased in Q1. Surveyed manufacturing firms expect input cost pressure to soften in Q2 on account of lower raw material costs. This points to a broad based weak inflation pressures and tells to the durability of lower inflation; with consequent implications for future policy room.
2. Growth: As we have assessed before, India’s growth is facing an exceptional challenge on account of : One, the global downturn in manufacturing which will possibly be only further accentuated basis the most recent escalations in trade tensions; and Two, our local problem of a consumption slowdown basis the last few years of weak income growth finally meeting with tighter financing conditions. Given this, we think the RBI is still reasonably sanguine on its growth forecast. Thus overall real GDP for FY20 has been only marginally cut by 0.1% to 6.9%. Further, most of this cut is only assessed in the first quarter, with subsequent quarters broadly on track from the previous forecast. Risks are also considered only ‘somewhat to the downside’. While there are positive near term data points to buttress RBI’s assessment (RBI’s business assessment index, recent manufacturing and services PMIs etc), we do think the system is experiencing a remarkable lack of growth drivers in a very uncertain world. Hence, we think there is scope for significant disappointment to the RBI’s current forecast for growth.
Given the above, and especially our view on growth, the following points bear note from the policy document and the governor’s further statements:
1. Addressing growth concerns by boosting aggregate demand, especially private investment, assumes the highest priority at this juncture.
2. Determining factor is to fill the output gap right now: this was said by the Governor in the post policy media interaction where he again underplayed the role of any real rate framework for policy setting and instead mentioned the focus on filling output gap.
With this clear stance of the current policy objective alongside weak inflation pressures and a probable overestimation of growth, we reiterate our previously expressed view of a terminal repo rate of 5%(see https://www.idfcmf.com/insights/managing-financial-conditions/), alongside provisioning of comfortable positive liquidity. With liquidity in surplus and banks’ credit growth slowing, term spreads are still attractive and this remains a continued bullish backdrop for quality bonds.
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