RBI POLICY – Surprise Pause, but remains “Accommodative”

05 DECEMBER 2019

The Fifth Bi-Monthly Monetary Policy Statement for FY 2019-2020 was released by the Reserve Bank of India (RBI) on 5th December 2019. Following were the key highlights.

1. Repo rate was left unchanged at 5.15%.

2. Stance left unchanged as “Accommodative”.

Consequently, the reverse repo rate and the marginal standing facility (MSF) rate / Bank rate remains unchanged at 4.90% and 5.40% respectively.

The Monetary Policy Committee (MPC) surprised markets by unanimously turning risk averse at the first signs of rising inflation. The ‘pause’ in the rate-cut cycle was, however, accompanied by a strong forward guidance indicating that there is space for further cuts, possibly prolonging the easing cycle.

Assessment & Outlook

  • Citi analysts expect headline Consumer Price Inflation (CPI) to rise to 5.5-6% levels by Feb 2020, before softening again towards Apr 2020, led by a reversal in Food CPI.
  • Citi analysts expect the RBI to stay on ‘pause’ through Feb 2020 policy review as well. They expect two rate cuts of 25bps each in Apr and Jun 2020.
  • Given the increased risk of fiscal slippage and higher CPI projections, Citi analysts expect 10yr G-sec bond yields to push upwards to 6.75% in the near term.
  • Citi analysts expect policy rate to be determined by inflation data going forward, as growth outlook remains subdued.

RBI’s Growth and Inflation Guidance

  • Real Gross Domestic Product (GDP) growth expectation for FY20 was revised sharply down by 110bps to 5.0% YoY (from 6.1% projected in Oct19 policy review). The RBI expects India’s GDP to grow by 4.9-5.5% YoY in 2HFY20 and 5.9-6.3% in 1HFY21.
  • CPI projections for 2HFY20 was revised upwards to 4.7-5.1% YoY (from 3.5-3.7% estimated earlier).
  • Expecting a turnaround in vegetable prices in early Feb 2020, the RBI expects headline CPI to moderate to 3.8-4% YoY in 1HFY21.

10 yr G-Sec movement around the current & previous RBI Policies

Source: Bloomberg

In addition to increasing food prices, the 120-180bps rise in household inflation expectation may have prompted the RBI to ‘wait and watch’ the CPI trajectory over the next few months, as per Citi analysts. They believe that the MPC may have resolved to retain some ‘tactical’ flexibility in case fiscal slippage in the Feb 2020 budget comes higher than expected, that may lead to volatility in the bond markets. The RBI however expressed satisfaction over the improvement in transmission of monetary policy, as Weighted Average Lending Rate (WALR) on fresh rupee loans declined by 44bps in the Feb-Oct19 period, against a 135bps cumulative reduction in the policy repo rate.

10yr G-sec Bond yields rose 15bps to close at 6.61% on Dec 5th, as market expectations of another 25bps reduction in the policy repo rate remained unfulfilled. Given limited room for further fiscal stimulus, Citi analysts believe that support from monetary policy is essential to effect a meaningful revival in growth.

Fixed Income investors may continue to focus on high credit quality with a preference for short duration and remain diversified in their portfolios. For more details and implications for your portfolio, please contact your relationship manager.

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