RBI Maintains Status Quo; G-Sec Yields Fall to an 8-month Low

The Reserve Bank of India (RBI), in its fifth bi-monthly policy review kept the benchmark repo rate unchanged at 6.5%. All six monetary policy members voted for a status quo, while one member voted to change the stance to neutral.

The decision of the MPC members is in line with market expectations. As per a Reuters poll of 70 economists, taken between November 22-28, majority of the participants said that the RBI would hold its repo rate at 6.50% in the December meeting.

The central bank was expected to keep rates unchanged, as over the past couple of months the inflationary risks eased. Retail inflation in September and October remained below 4%, while crude oil prices have eased by nearly 30% from its peak in October, and the rupee too, has strengthened over this period.

The MPC members held their stance of a Calibrated Tightening, thereby signalling that an interest rate hike is still not off the cards.

The MPC noted that the benign outlook for headline inflation is driven mainly by the unexpected softening of food inflation and collapse in oil prices in a relatively short period of time. The MPC also noted that even as escalating trade tensions, tightening of global financial conditions and slowing down of global demand pose some downside risks to the domestic economy, the decline in oil prices in recent weeks, if sustained, will provide tailwinds.

What has changed since the last monetary policy meeting?

Inflation remains subdued and is in line with RBI expectations

Consumer price inflation for October eased to a 13-month low as food prices remained subdued. Retail inflation rose 3.31% (y-o-y) in October as compared to 3.77% in September. The drop in consumer prices was mainly due to the fall in food prices.

The inflation rate remains below the Reserve Bank of India’s (RBI) medium-term target of 4% for a third straight month, allowing room for the central bank to hold interest rates.

According to the RBI’s statement, a large fall in food prices pushed food group into deflation and more than offset the increase in inflation in items excluding food and fuel. Adjusting for the estimated impact of an increase in house rent allowance (HRA) for central government employees, headline inflation was 3.1 per cent in October.

Taking all these factors into consideration and assuming a normal monsoon in 2019, the RBI expects inflation to be at 2.7-3.2 per cent in H2:2018-19 and 3.8-4.2 per cent in H1:2019-20, with risks tilted to the upside.

Brent crude has eased from its highs, receding inflationary pressures

Brent Crude has corrected by nearly 30% from a high of $85/bbl hit early October to $60/bbl as on November 26, 2018. This sharp correction will further ebb inflation risks.

Over the same period, the rupee strengthened from a low of around Rs74/USD to nearly Rs70/USD. This does ease fiscal concerns to an extent, but on a YoY basis the Indian currency is still down by over 10%.

Industrial growth slips to 4.5%

Slower growth in factory output, despite the onset of the festival season has been a disappointment. The industrial output for the first half of this financial year, grew 5.1% as against growth of 2.6% last year.

However, the Nikkei India Manufacturing PMI rose unexpectedly to a four-month high of 53.1 in October 2018 from 52.2 in September and beating market forecasts of 51.9. Goods producers see challenges and uncertainties ahead, which in turn translated into the weakest sentiment seen in 20 months.

GDP growth slows to 7.1%

India’s Gross Domestic Product (GDP) growth came in at 7.1% for the July-October quarter of the financial year 2018-19 as against 8.2% registered in the previous quarter. Rating agencies and research houses expected GDP to slow down to somewhere between 7.2%-7.6%.

Based on RBI’s overall assessment, GDP growth for 2018-19 has been projected at 7.4% (7.2-7.3 per cent in H2) as in the October policy, and for H1:2019-20 at 7.5%, with risks somewhat to the downside

How did the market react?

The stock market had already priced in a status quo decision. Hence, the Nifty 50, which opened the day lower at 10,820 remained flat since then, trading in a narrow range between 10,748 and 10,821. The Nifty 50 closed at 10,785, down 0.74% from its previous day close.

The 10-year benchmark G-Sec yield cooled off significantly, dropping to an 8-month low of 7.45% from 7.57% at the beginning of the day. G-Sec yields had peaked to 8.23% in September 2018.

The next Monetary Policy statement will be issued on February 6, 2019. The decision on interest rates will depend on several variables. However, a majority of economists surveyed do not expect a rate cut until the end of the current fiscal year.

The latest poll by Reuters forecasts the RBI to hike its repo rate in the April-June quarter next year, taking it to 6.75%, and then to hold it steady for at least another year.

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