RBI Monetary Policy – Back to baby steps, but still way to go

After a surprise 35bp rate cut at the last policy meeting, the RBI is back to a 25bp rate cut, which was the lower end of the consensus expectation.

Yet, with sharply reduced growth estimates and a benign view on inflation, it is expected the bank to further reduce the repo rate, by 65bps, to 4.5% in the current rate-cut cycle. It is expected the stance to be positive for interest-sensitive sectors, excl. financials. Bond yields, too, should soften.

The backdrop. The October 19 monetary policy meet was preceded by Q1 FY20 multi-year-low GDP growth and infra index on August 19. Numerous administrative measures by the government to boost business confidence and the historic decision to sharply lower the corporate tax rate, especially for new businesses, has not yet lifted the pall of gloom. Low consumer demand, in particular, remains a major worry.

RBI voiced concerns on growth, less worried about inflation. The RBI has revised the FY20 growth estimate by 80bps to 6.1%. While the estimates factor in a rebound in H2 FY20, even the extent of recovery has been scaled down as also the Q1 FY21 growth rate. In contrast, while the RBI has raised the Q2 FY20 retail inflation forecast, the H2 FY20 and Q1 FY21 rates were left unchanged. The RBI points out that growth concerns encompass not only industry and infra, but also the more resilient services sector.

Back to baby steps, but way to go. After the surprise 35bp rate cut at the last policy, the RBI reduced the policy rate by 25bps, in line with our expectation but lower than the higher end of the consensus expectation. Yet, the RBI’s concern regarding growth, its comfort concerning inflationary dynamics, its talk of continuing its accommodative stance and its resolve to aid the country to revert to a high growth path seem to suggest that, even with the current repo rate being close to a record low, monetary easing is far from over. With this, we expect that during the current easing cycle the repo rate would bottom out at 4.5% rather than at 5% (as we anticipated earlier).

Positive on interest-sensitive sectors, excl. financials. With the likely greater-than-expected policy-rate cut and the RBI’s resolve to ensure the transmission of policy rates to lending rates, we expect interest-sensitive sectors such as auto, capital goods and consumer durables to be positively impacted. With the pressures to transmit policy-rate cuts, low system credit growth and unfavourable developments in the financial sector (cooperative banks, select NBFCs and private banks), financials may not do so well. Yet, the increase in lending limits for NBFC-MFI would positively impact these companies. A deeper rate cut would build pressures on the rupee to depreciate, which would help IT companies.

Developmental measures. Today’s policy also announced developmental measures relating to offshore rupee markets, non-resident rupee accounts, liquidity support to the payments system and digital transactions.

Risks to growth, lowering estimates. With the RBI’s deep cut to growth estimates and its less sanguine stance regarding the near-term outlook, the downside risk to our FY20 6.5% growth estimate increases. Yet, we feel that the recovery in H2 FY20 is likely to be more robust than the RBI estimate (6.6-7.2%). Consequently, we revise our FY20 growth to 6.3% vs. the RBI’s 6.1%. We retain out retail inflation forecast of 3.7% for FY20.

Outlook. We expect the RBI to continue with a rate cut at least twice in FY20. With greater emphasis from both the government and the RBI, we expect signs of growth recovery to become visible in the current quarter. This would give the equity market a fillip. A more-than-expected rate cut coupled with better transmission to the credit market would also generate better sentiment in the bond market.

Views expressed in this article is a personal opinion of Sujan Hajra, Chief Economist
and Yuvraj Choudhari, Research Analyst from Anand Rathi Research.

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