Rbi Review Apr19.pdf

Economics Research

Easing with caution 04 APRIL 2019 RBI cut Repo rate by 25bps with a 4:2 margin with the mix of members voting for/against the resolution remaining the same as in February. Importantly, the near term factors have led the RBI to revise down its inflation and growth expectations. However, the stance has been left unchanged at “neutral” that allows flexibility to react to evolving data. This is in line with RBI’s assessment that risks to inflation are “broadly balanced”. One last 25bps cut is most likely in this cycle, though predicting the timing remains tricky. Our base case is for the RBI to delay this cut into August, as it waits for the monsoon to evolve (chances of an El Nino have emerged) and also sees through the elections and Union Budget of the new government.

Highlights 

RBI cuts policy rate by 25bps; stance retained as “neutral”



RBI revises down its inflation forecast: H1FY20 now at 2.9-3.0%, H2FY20 at 3.5-3.8%



Revises down FY20 GDP growth to 7.2% from 7.4% earlier



We expect a data-driven RBI to cut one more time by 25bps in this cycle; timing remains uncertain

Indranil Pan [email protected] +91-22-7132 5631

Gaura Sen Gupta [email protected] +91-22-7132 5562

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Cuts policy rates supported by a slash in the inflation trajectory: The RBI further cut inflation forecast, incorporating the undershooting of recent inflation prints. RBI’s inflation trajectory now shows inflation not exceeding 3.8% in FY20, versus its earlier forecast of 3.9% in February policy. Inflation for FY21 was unveiled ranging between 3.8% to 4.1%, with inflation reaching 4% in H2FY21. Moreover, the upside risk to core inflation has moderated with output gap remaining negative and continued reduction in inflation expectation – both three-months and one-year ahead lower by 40bps each. With inflation expected to remain comfortably below the 4% target in FY20, we expect monetary policy to stay focused on growth perspectives. The policy statement did highlight the need to strengthen domestic growth impulses, specifically investment. High frequency growth indicators have been indicating weakening growth impulses in H2FY19 from both the consumption and investment oriented sectors. RBI revised down the FY20 GDP forecast to 7.2% (previously 7.4%), with growth in H1FY20 and H2FY20 averaging at 7% and 7.4% respectively. However, “neutral” stance was maintained: The fan chart for inflation continues to remain tilted to the upside. Even as the inflation forecasts were slashed, the RBI has taken cognizance of the uncertainties to the trajectory of Headline inflation. The policy highlights some risks to inflation: 1) abrupt reversal in vegetable prices, 2) nonsustenance of the recent softness of fuel prices, 3) risks of El Nino and hence poor monsoons in 2019, 4) hazy oil prices (RBI’s model considers oil prices to average at US$67/bbl), and 5) global financial market volatility (Brexit and USChina trade talks). The policy document also points out that the RBI would be carefully monitoring the fiscal situation. Given these uncertainties, MPC members were not in a position to change the stance immediately and therefore, retained with itself the flexibility to act as per the incoming data. Expecting one more cut: Near term data has, no doubt, led the softening of inflation and growth expectations of the RBI. However, as indicated in the last para, RBI continues to project inflation to go up from here on. Factoring the above and expecting the growth trajectory not to be smooth due to both domestic and global issues, we see one more cut of 25bps by the RBI in this cycle. However, we see a realistic chance for this to be delivered only after having taken full cognizance of monsoon and fiscal risks. Consequently, we have a higher probability for a 25bps repo rate cut in August than in June. A June cut could be made possible if the next couple of readings on inflation undershoots the current expected trajectory, if global growth slumps faster than expected, or if oil prices ease back on the back of erosion of global growth. The focus of monetary management will now be more on achieving transmission. There is however no clear commitment on the liquidity stance by RBI and this could impede transmission. The easier monetary policy is unlikely to change the direction of G-sec yields. In-fact, 10-year G-sec yield moved up by almost 10bps from the prepolicy levels and ended the day at around 7.35%. Supply pressures and expected lower-than-last year OMO purchases by RBI (in context of the new liquidity infusion tool of the RBI in the form of USD swaps) is likely to keep the 10-year bond yield in a range of 7.30-7.65%, with a steepening bias to the curve.

“Important disclosures appear at the back of this report”

POLICY REVIEW

RBI

RBI Exhibit 1: Downward revision in RBI’s CPI inflation forecast

Exhibit 2: RBI revises down GDP estimate

CPI inflation YoY%

3.5

3.2 3.5

3.0

2.8

2.9

2.5

6.5

7.35

7.3

7.45

7.35

7.1

6.5

6.1 Q4FY19E

Q4FY21E

Q3FY21E

Q2FY21E

Q1FY21E

Q4FY20E

Q3FY20E

Q2FY20E

Q1FY20E

Q4FY19E

Q3FY19

7.3 7.4

6.8

6.6

6.3

2.4

1.9

6.9

6.8

6.9

2.8

2.4 2.4

7.3

6.7

2.9

2.4

7.1

Q4FY21E

3.4

7.3

RBI April forecast

Q3FY21E

3.4

RBI Feb forecast

Q2FY21E

3.8

7.5

Q1FY21E

3.8

4.0

4.0

3.9

Q4FY20E

3.9

7.7

Q3FY20E

3.9

GDP growth YoY% IDFC FIRST bank forecast 7.5 7.4 7.5 7.2 7.2

RBI Apr forecast

Q2FY20E

4.4

7.9

RBI Feb forecast

Q1FY20E

IDFC FIRST Bank forecast

Source: RBI, IDFC FIRST Bank Economics Research. FY20 imputed from RBI’s inflation fan chart

Source: CEIC, IDFC FIRST Bank Economics Research. FY20 imputed from RBI’s inflation fan chart

Exhibit 3: Inflation expectations moderate

Exhibit 4: Capacity utilization improves

12.0

Inflation expectations 3-month ahead

11.0

Capacity Utilization 4Q ma (% )

79

11.5

78

1-year ahead

77

10.5

76

10.0

75

9.5

74

9.0

73

8.5

72

8.0

71

7.5

09-2018

03-2018

03-2017

09-2017

03-2016

09-2016

09-2015

09-2014

03-2015

09-2013

03-2014

09-2012

03-2013

03-2012

03-2011

09-2011

03-2010

09-2010

09-2009

09-2008

Jan/19

Mar/19

Sep/18

Nov/18

Jul/18

May/18

Jan/18

Mar/18

Sep/17

Nov/17

Jul/17

Mar/17

May/17

Jan/17

Nov/16

Jul/16

Sep/16

Mar/16

May/16

Source: RBI, IDFC FIRST Bank Economics Research

03-2009

70

7.0

Source: CEIC, IDFC FIRST Bank Economics Research

Exhibit 5: MPC voting pattern February MPC members

April

Policy rate

Stance

Policy rate

Stance

25bps cut

Neutral

25bps cut

Neutral

Hold

Neutral

Hold

Neutral

Dr. Ravindra H. Dholakia

25bps cut

Neutral

25bps cut

Accommodative

Dr. Michael Debabrata Patra

Dr. Pami Dua Dr. Chetan Ghate

25bps cut

Neutral

25bps cut

Neutral

Dr. Viral V. Acharya

Hold

Neutral

Hold

Neutral

Shri Shaktikanta Das

25bps cut

Neutral

25bps cut

Neutral

Outcome

25bps cut

Changed to Neutral

25bps cut

Retained Neutral

Source: RBI, IDFC FIRST Bank Economics Research

2 | IDFC FIRST BANK ECONOMICS RESEARCH

04 April 2019

RBI

Transmission of rate cuts likely limited The rate cutting cycle initiated by the RBI in February of this year is taking place against the backdrop of rising bank credit growth, currently growing at 14.5%YoY. Part of this rise in bank credit has been due to the NBFC crisis, with banks significantly increasing their lending to NBFCs by 47% in FYTD19 (till February). However, this has and will limit transmission, as credit growth has significantly outstripped deposit growth resulting in elevated credit-to-deposit ratio at 78%. Indeed, as per the RBI Monetary Policy Report, following the 25bps policy rate cut in February, 38 banks have reduced their MCLR in the range of 1-106bps, while foreign banks have increased their MCLR in the range of 5-113bps. The transmission is limited by the fact that very few products on the liability side of the banking system are priced on a floating rate basis (term deposits account for 58.7% of total deposits). To help the transmission process, RBI had suggested that starting from 01 April 2019, all new floating rate personal, retail and MSME loans will have to be benchmarked to either of a) RBI policy repo rate, b) 91- or 182- day T-bill yield or c) any other market interest rate benchmark produced by Financial Benchmarks India Private Ltd (FBIL). However, issues raised by banks such as management of interest rate risk from fixed interest rate linked liability against floating interest rate linked assets, resulted in RBI now postponing the implementation of this. Another channel to improve transmission could be maintaining surplus liquidity conditions. Currently, liquidity deficit conditions prevail due to high currency growth in the run-up to elections as well as moderation in government expenditure. Until very recently, another key source of liquidity drain was from FX interventions, balanced by OMO purchases worth INR3tn in FY19. The RBI has also added another durable liquidity tool – USDINR Buy/Sell swaps, to reduce its dependence on OMO purchases. In today’s policy the RBI further augmented liquidity of the banking system by increasing FALLCR to 15% from existing 13%, which will be implemented in a phased manner. The market was looking forward to some assessment from the RBI with respect to its future stance on liquidity. Given that there is no explicit announcement on the same, transmission of this 25bps cut in the Repo rate could be on the lower side. Exhibit 6: Composition of banking sector deposits As of December 2018

INR bn

Share in total deposits

Current

Savings

Terms

Total

Current

Savings

Terms

Total

Foreign banks

1581

570

3221

5372

29.4

10.6

60.0

100.0

Private sector banks

4019

9276

18401

31696

12.7

29.3

58.1

100.0

Public sector banks

4758

27495

47162

79415

6.0

34.6

59.4

100.0

Regional rural banks

155

2020

1861

4036

3.8

50.0

46.1

100.0

Small finance banks SCBs

12

65

223

300

4.2

21.5

74.3

100.0

10525

39426

70868

120819

8.7

32.6

58.7

100.0

Source: RBI, IDFC FIRST Bank Economics Research

3 | IDFC FIRST BANK ECONOMICS RESEARCH

04 April 2019

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04 April 2019