A status quo that shocked the market but a change in stance has reasons to cheer
The Monetary Policy Committee (MPC) bowled a ‘wrong un’ through their policy by keeping interest rates unchanged. The market clearly was not happy with what came its way. An interest rate hike was a given by most economists and analysts; the only point of contention was the percentage by which repo rates would be increased.
But after two consecutive rate hikes, the central bank decided to hit the pause button. It has further presented a dovish picture of the economy. There is a clear disconnect between market behaviour and the contents of the MPC document.
RBI seems to be more focused on keeping inflation under check rather than playing to the market's expectations. RBI Governor Urjit Patel said the main risk to the economy is emerging from the US Federal Reserve tightening rates and the escalating trade wars impacting all economies. However, he pointed out that fiscal slippage by states or centre will have a bearing on the inflation outlook.
An important announcement has been a change in stance from 'neutral' to 'calibrated tightening'. This means the rates could either be maintained or increased in the current cycle.Here are 10 key takeaways from the MPC report:
1. Domestic economy on firm ground: The policy states almost all engines of the domestic economy are firing. Gross domestic product (GDP) growth has surged to a nine-quarter high of 8.2 percent in the first quarter of current fiscal which is on the back of sequential acceleration to four successive quarters. The core of economic growth -- gross fixed capital formation (GFCF) has expanded by double digits for the second consecutive quarter, driven by the government’s focus on the road sector and affordable housing suggesting multiplier growth going forward. Manufacturing activity posted a double-digit expansion while seasonally adjusted capacity utilization continued to remain high.
2. Indians are consuming more: Growth in private consumption both at the urban and rural end is strong. Growth in private final consumption expenditure (PFCE) accelerated to 8.6 percent, reflecting rising rural and urban spending, supported by retail credit growth, says the policy document.
3. Exporters have come to the party: Exports of both goods, especially non-oil goods and services have jumped to 12.7 percent thanks to a strong global demand. Though import growth was strong higher export growth will augur well for the trade deficit.
4. Farmers on fire: Joining the manufacturing sector agriculture too continues to remain strong despite a near 9 percent monsoon deficit. The fourth advance estimates of agricultural production for 2017-18 released in August placed foodgrains production at a high of 284.8 million tonnes –3.5 percent higher than the final estimates for the previous year. More importantly, live storage in major reservoirs (as on September 27) rose to 76 percent of the full capacity, which was 17 percent higher than last year and 5 percent more than the average of the last 10 years suggesting a good rabi crop.
5. Some signs of fatigue: While the overall picture looks hunky dory some high-frequency indicators presented a mixed picture. Rural demand measured through sales of tractor and two-wheeler sales slowed down. Even passenger vehicle sales, an indicator of urban demand, declined, which the policy says could be due to rising fuel prices.
6. Inflation under control, for now: Retail inflation fell from 4.9 percent in June to 3.7 percent in August dragged down by a decline in food inflation. Fuel inflation though rose on the back of a significant increase in LPG prices. The MPC pointed out that fiscal slippages by states and centre along with the recent increase in minimum support price (MSP) can have an impact on inflation going forward. As a result, the central bank has changed its stance from ‘neutral’ to ‘calibrated tightening’. Governor Patel said rate cuts in the current cycle are now off the table.
7. Liquidity continues to be fluid: For the first time in recent past, liquidity measures by the central bank was keenly followed. According to the policy statement, systemic liquidity alternated between surplus and deficit during August-September 2018 due to the impact of the expansion of currency in circulation, the central bank’s forex operations and movements in government cash balances. RBI conducted two open market purchase operations (OMO) in the second half of September to inject Rs 20,000 crore.
8. Headwinds in the global economy: The ongoing trade war is impacting global economies. China is hit by slowing industrial production from weaker exports thanks to the measures imposed by the US government. Rising commodity prices, however, are benefiting the Russian economy. However, growth in global trade is weakening as reflected in export orders.
9. Global financial markets affected by the US Fed: The continued rate increase by the US Fed has impacted most global financial markets and spreading of contagion risks from specific emerging economies and geopolitical developments. While the US and markets in Japan are strong, those in the Euro area suffered due to a slowdown and budget concerns in some member states. Emerging market equities have taken a beating on waning appetite of foreign portfolio investors. Emerging markets treasury yields rose due to domestic factors and contagion effects.
10. Outlook: Inflation is projected at 3.9-4.5 percent in the second half and 4.8 percent in the first quarter of next fiscal. As far as growth is concerned GDP growth projection for 2018-19 is retained at 7.4 percent. However, GDP growth for the first quarter of next fiscal has been lowered marginally to 7.4 percent as against 7.5 percent earlier.The outlook provided by the central banker does not go along with the doomsday scenario that is being projected by the market.