The commentary notes upside pressure to food prices, but a broad-based decline in core inflation on the back of ‘significant’ weakening of demand conditions. Crude prices are volatile, but near-term inflation expectations of households have continued to moderate.
Acknowledging slowdown in growth drivers, the gross domestic product (GDP) forecast is revised lower to 6.4-6.7 per cent in H1 (from 6.8-7.1 per cent) and 7.2-7.5 per cent in H2 (from 7.3-7.4 per cent).
The MPC notes that “growth impulses have weakened significantly as reflected in a further widening of the output gap compared with the April 2019 policy”.
Though the change in stance is being seen as unnecessary this late in the cycle, what has been done has only rectified the under-utilisation of a potent policy tool.
The RBI also seems to have de facto adopted a positive liquidity stance. This is evident in the core liquidity having turned positive some time back and yet the RBI having persisted with further injection tools, including an open market operations (OMOs) that is scheduled for mid-June. Now with the government spending happening, the headline liquidity is positive too.
Further, an internal working group has been constituted to review the existing liquidity management framework and suggest measures, among others, to simplify the current liquidity management framework, and clearly communicate the objectives, quantitative measures and toolkit of liquidity management by the RBI. The group is expected to submit its report by mid-July 2019.
The one aspect that we have been disappointed with is the continued insistence to not anchor the monetary policy to some sort of a better defined real rate framework. The RBI governor was emphatic in saying observers will have to deduce this via RBI/MPC actions and he would not commit to anything on this point.
However, so long as the absence of this framework doesn’t impart a systematic hawkish bias to policy (as seems to have been the case in the past), this may not be a constraint at least in the near term.
The other notable aspects of the post-policy press conference were:
1. The RBI governor seems to have a reasonably benign view on government finances. Thus, he underplayed the recent stress instead focusing on the consolidation underway over the past few years. Furthermore, he also doesn’t seem to be unduly concerned about the PSU borrowings saying borrowings done by PSUs, which have own revenue streams, shouldn’t be looked upon as government borrowing.
This is somewhat surprising since the common perception is that at least some part of the heavier than usual PSU borrowings recently has been to compensate for lack of budget resource availability. Similarly, the heavier usage of small savings was not considered to be a sticky point.
2. Given large buffer stocks (3.4 times the prescribed norm), there seems to be less of a concern from an inflation perspective, in case monsoon turn out to be weaker. This is the right approach. We have gone a step further to argue that even if prices were to rise on the back of a supply shock, they are unlikely to have second round effects and hence are unlikely to be relevant from a monetary policy standpoint.
3. A welcome clarification has been provided with respect to state development loans (SDL) with the governor explicitly stating that they have implicit sovereign guarantee and that the RBI automatically debits state accounts at time of payment. It is relevant since a recent push by the RBI towards asking states to get rated was somewhat muddying the risk perception. A question could always be asked as to what the importance of rating was for a sovereign backed asset? The clarification conclusively clears the air.
World growth expectations have taken a decided turn towards the worse over the past month or so. This is now reflected in expectations of easing by major central banks later in the year. As an example, the US yield curve is now reasonably inverted up to 10 years with market expecting 2-3 rate cuts in the future.
Locally as well, there has been a marked deterioration in growth drivers with consumption being the latest casualty, probably, courtesy an impact to leverage given the ongoing stresses in certain parts of the financing market. Thus, the current monetary easing underway has to be looked at in this context.
While currently the expectation would be for one last rate cut along side continued easy liquidity, it can quickly change towards expecting a deeper further easing should the global outlook further deteriorate.
The next major domestic trigger is going to be the Union Budget in early July. Given the large undershoots in the actual revenue collections in FY19 versus even the revised numbers presented in February, the numbers targeted in the interim budget are looking truly daunting. This is especially in context of the ongoing growth slowdown.
The new Finance Minister will have to present a credible budget, while sticking to the assumed deficit target. In this context, the Jalan Committee report on potential excess RBI reserves and their usage by the government will assume importance.
From a bond market standpoint, the focus should remain on quality rates (sovereign, SDL, AAA) as the best vehicles to play the current macro environment. As developments continually highlight, the lower rated credit markets are far from settled and the spreads that can effectively be captured there may not yet be compensating for the risks involved.
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