The RBI announced the Monetary Policy of 2018 on 7th Feb 2018 – keeping the repo rate unchanged. Here are the details you need to know from this policy.
In this article
Pre Policy Scenario
The RBI Monetary policy has been pronounced by the 6 member Monetary policy committed headed by Reserve Bank of India (RBI) governor Urjit Patel. The repo rate has been kept unchanged at 6% and the forecast for inflation has been raised from 5.1 to 5.6% in April to October.
Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) grants money to commercial banks. This rate is used by monetary authorities to combat inflation.
In case of inflation, central banks raise repo rate as this demotivates banks to borrow from the central bank. This ultimately decreases the money supply in the economy and thus assists in combating inflation.
The central bank takes an opposite stance in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.
The Central Bank of India’s two-day Monetary Policy Committee (MPC) meeting concluded today for the sixth bi-monthly monetary policy statement.
It was largely anticipated that the RBI might not likely trifle with rates when it announces the decision of its Monetary Policy Committee meeting, the first policy decision of the year 2018 and the first after the Union Budget 2018.
The Consumer Price Inflation (CPI) increased to 5.21 percent in December, thereby crossing the anticipated zone. RBI was expected to keep an eye on how the declining impact of the central government’s (House Rent Allowance) HRA element along with pass-through of a fall in GST rates effects inflation in the coming months.
Majority of the economists expected RBI to keep the repo rate unchanged at 6%. Very few expected a 25 basis point increase in the repo rate. One basis point is a hundredth of a percentage point.
Most economists, however, anticipated RBI to sound hawkish, hinting at a possible rate increase in FY19
Market’s response before the MPC meet
Ahead of the policy, the Nifty auto index was trading positively, gaining 1 percent led by Tata Motors, Hero MotoCorp, Apollo Tyres, TVS Motor, Ashok Leyland and Amara Raja Batteries.
A repo rate cut or not but the reality space increased close to 2 percent as stocks like Sobha, Phoenix Mills, Godrej Properties, Unitech, DLF and Delta Corp were all increased by 1-2 percent.
However, the Bank Nifty slid in the red and was trading marginally lower by 0.18 percent dragged by PNB which reduced by 2 percent while HDFC Bank was low by 1 percent.
Things to See in the Monetary Policy
A combination of factors, including increasing oil prices, fiscal slippage and impact of higher support price for the farmers, were the things likely to impact RBI’s policy decision.
In the December monetary policy, RBI had increased its fiscal second half inflation prediction to 4.3-4.7% from 4.2-4.6%. But retail inflation, as calculated by the Consumer Price Index (CPI), touched 5.2% in December as vegetable and fuel prices toughened.
Increasing oil prices, lasting impact of the increase in House Rent Allowance, as part of the 7th Pay Commission, and an expansionary budget are expected to keep future inflation prints elevated.
In addition to that, some economists were also considering the potential effect of the budget announcement to allow Minimum Support Price (MSP) of kharif crops 50% higher than the cost of production on inflation. RBI was, therefore, likely to raise the inflation forecast for next year.
In the last policy, FY18 growth forecast was kept unchanged at 6.7%. RBI was expected to peg the growth prediction for 2018-19 at 7-7.5%. Most research houses are expecting a strong recovery beginning in the fourth quarter.
Non-food bank credit rose by 10% in December in contrast with 4% growth in the same period last year. Recapitalisation of public sector banks might assist in improving credit flows further.
The government reviewed and changed the fiscal deficit target for FY18 to 3.5% of the GDP and FY19 to 3.3%. Economists anticipate an upside risk to the fiscal deficit next year, given the ambitious growth projection on tax collection and increased government spending ahead of elections.
Increasing oil prices could also increase the fiscal deficit burden, resulting in increased government borrowing. RBI’s statement on the fiscal deficit was, therefore, heavily watched.
Industry Expert’s Views
- DBS: DBS believed that RBI was likely to factor in the forecasted fiscal slippage. The combination of fiscal challenges and increasing oil prices make RBI’s policy path a complicated one this year.
Growth has largely bottomed out, but India has yet to take advantage from the synchronized increase in global demand. With this regard, DBS anticipated the monetary policy committee to turn hawkish, but not enough that it could result towards a rate increase.
They believed RBI to forecast an increased inflation estimates and revise down its Gross Value-added growth forecast for FY18. For now, DBS was retaining its base case for an unchanged policy bias in 2018 based on their assumption that inflation will moderate towards 4 percent in H2 2018.
DBS admitted that the odds for a rate increase to be brought forward to H2 would increase if inflation proves sticky around 5 percent from the MSPs and persistently higher oil prices.
- Nomura: Nomura India anticipated RBI to take risk of higher Minimum Selling Price and slower fiscal consolidation as a medium-term risk to inflation.
If the MSP rise is much greater, it could feed into increased inflation and rise in the chances of a tighter monetary policy. Oil prices are another threat.
- Bank of America: Macro risks to the bond market are done with RBI stepping up durable reserve money introduction to $27 billion from barely $4 billion in end-November.
BOFA anticipated central bank to come out with confidence-building measures (CBMs) – eg, FPI limit hike This would make investors buy Government Securities that are more and more seen as a falling knife.
In sum, open mouth operations will be as critical as open market operations (OMO) on 8th February (Wednesday).
- Edelweiss: In the past two months, Reserve Bank of India in the developed world have turned a bit more hawkish.
While the Fed already on the path of increasing interest rates and shrinking its balance sheet, ECB to seems too turning less friendly, embarking on a tapering plan and stating that Euro area growth remains robust.
Post Policy Scenario
The RBI credit policy 2018 was an exercise to make sure that the signal of recovery did not get wiped out by the Reserve Bank of India becoming an inflation hawk.
It is important to note that one member out of six was in favor of a rate hike. But the Central Bank decided the other way and to increase rate only when growth makes a decisive comeback.
- GST implementation is stabilizing, which is a good sign for future economic activity.
- There are early signals of recovery in investment activity as is seen in improving credit offtake, large resource mobilization from the primary capital market, and boosting capital goods manufacturing and imports.
- The process of recapitalization of Public Sector Banks has got underway. Largely distressed borrowers are being referenced for resolution under the Insolvency and Bankruptcy Code. This should improve credit flows further and generate demand for fresh investment.
- Although export development is anticipated to improve further on account of improving global demand, higher commodity prices, especially those of oil, may act as a drag on aggregate demand.
- Keeping in mind the Centre’s inclination towards agriculture, farmers and infra sectors, the Monetary Policy Committee noted that it would support rural income and investment, and in turn provide a further push to aggregate demand and economic activity. It also said the economy is on a recovery path, including early signals of a recovery of investment activity.
Points to Note
- Global trade continues to increase, underpinned by robust investment and manufacturing activity.
- Financial markets volatile of late due to unpredictability over the stride of like US Fed rate increase. Good US January employment data points to a faster pace of increase.
- Advance Central Statistics Office (CSO) forecast show Gross Value Added (GVA) coming down to 6.1 percent in 2017-18 from 6.6 percent in 2016-17 because of a slowdown in agriculture, mining, manufacturing, public administration and defense services.
- Some high-frequency indicators for services sector are getting better. Commercial vehicle sales were at 8 years high in December; cargo movement was high in November, mixed in December. Domestic and international air passenger traffic and foreign tourist arrivals were rising in November-December.
- Retail inflation was up for the sixth consecutive month in December, because of low base effect, increased food, and fuel prices, housing inflation due to increased House Rent Allowances for government employees under the 7th central pay commission (CPC).
- December quarter average inflation at 4.6 percent and March quarter forecasted at 5.1 percent. This is greater than the 4.3-4.7 percent range for the second half of this fiscal, projected in the previous RBI policy.
- Inflation outlook clouded by several doubtfulness on the upside, including higher MSPs for farmers, and a greater than anticipated fiscal deficit figure for 2017-18 as well as 2018-19.
- Households’ inflation anticipations, measured by the Reserve Bank’s survey of households, remained elevated for both three-month ahead and one-year ahead.
- Liquidity in the system remains to be in surplus mode, but moving comfortability towards neutrality.
- Merchandise exports bounce back in November and December, led by petroleum products, engineering goods and chemicals. Exports of readymade garments shrinked.
- Consumer Price Index inflation for first half of 2018-19 anticipated in the range of 5.1-5.6% due to increased crude, raw material prices. Second half inflation forecasted at 4.5-4.6 percent, with risks inclined to the upside.
- Gross Value Added growth for 2017-18 forecasted at 6.6%, down from the previous forecasting of 6.7 percent. Gross Value Added growth for 2018-19 forecasted at 7.2 per cent overall in the scale of 7.3-7.4% in H1 and 7.1-7.2% in H2.
- Central Bank to continue with neutral position, reaffirms dedication to keep inflation very close to 4 per cent on a durable basis.
- Economy on recovery path, including nascent signals of a recovery of investment activity. Global demand getting better, which should help improve domestic investment activity.
Sensex and NIFTY closed lower for a seven straight session on 7th Feb, with BSE Sensex closing 113 points down and NSE Nifty settling 21 points low as RBI kept monetary policy unchanged. Meanwhile, Midcap and Small cap stocks outperformed the Sensex by increasing 0.43% and 1.95%, respectively.
Among the sectoral index on BSE, oil and gas, realty, energy and healthcare made gains, while telecom, IT and technology fell.
The Central Bank on Wednesday kept interest rates unchanged but gave a hint that monetary conditions are likely to remain tight because of increasing risks to inflation.
BSE Sensex closed lower by 0.33% to 34,082.71, while the Nifty 50 decreased by 0.21%, to close at 10,476.70. Midcap increased by 0.43%, while Small cap increased by 1.95%.
The Indian rupee and bond prices increased after Central Bank of India kept its interest rates unchanged and monetary policy stance unchanged to neutral.
The rupee was trading at 64.14, up 0.16% from its previous close of 64.25. It opened at 64.11 a dollar and recorded a high and a low of 64.04 and 64.19, respectively. The 10-year bond yield was at 7.552% from its Monday’s close of 7.568%
Inflation not to Come Down Soon
The Reserve Bank of India said that the unsteady impact of Housing Rent Allowance (HRA) increases by state governments may increase headline inflation further over the baseline in 2018-19, and likely induce second-round effects.
Fiscal fall has wider macro-financial impact on inflation, notably on economy-wide costs of borrowing which have already started to increase. This may feed into inflation.
Domestic fiscal growth and normalisation of monetary policy by major advanced economies could further unfavorably effect financing conditions and reduce the motivation of external investors.
The Central Bank has partly factored in the likely effect of an increase in the Minimum Support Prices (MSPs) for kharif crops on inflation. The exact magnitude of its impact on inflation cannot be fully checked at this stage.
The proposed rise in a customs duty on a number of items may increase inflation. A pick-up in global development may exert further stress on crude oil and commodity prices with consequence for domestic inflation.
Thus, in this policy, while striking the balance between inflation vs growth, Central Bank has given priority to growth at this point, which should calm sentiments of an otherwise nervous market.
Disclaimer: the views expressed here are those of the author and not of Groww.