RBI maintains "calibrated tightening" despite lowering inflation projection
The RBI’s policy announcement of keeping the policy repo rate at 6.5% was in line with our expectations. The central bank’s unchanged “calibrated tightening” policy stance appears in contrast with the scaling-down of its inflation projection but is aligned with the high core inflation. We expect a status quo on rates and policy stance in the next 3-4 months. The banking sector measures ─ reduction in SLR, benchmark-linked lending rates, etc. ─ do not provide much respite, in our view.
Scales down projected inflation on transient factors: An important takeaway from the statement is that the projected inflation has been scaled down considerably in view of the transient downside surprises in food inflation and the recent decline in global oil prices. Accordingly, the headline CPI inflation is projected at 2.7-3.2% in H2FY19, down from 3.9- 4.5% projected earlier. In addition, H1FY20 projection for headline inflation at 3.8-4.2% is lower than the earlier projection for Q1FY20 at 4.8%.
However, notwithstanding the tapering of projected headline inflation, the RBI appears to be worried about core inflation, which has remained elevated at 6.1%. The RBI, therefore, kept the bias on projected inflation on the higher side. The high core inflation is seen as broadbased across non-food groups. Further, the steep decline in global crude prices is unlikely to result in lower non-food inflation as the RBI’s survey indicates that the selling prices of final products are expected to edge up on higher demand.
GDP growth near India’s potential level, small output-gap:
While the growth projection of 7.2-7.3% for H2FY19 is a decline from 7.7% in H1, growth is expected to improve in H1FY20 to 7.5%, marginally higher than the full-year projection of 7.4% in FY19. At these levels, the central bank believes that there is very little output gap, which implies higher inflation if future growth is propelled by consumption demand instead of investments. Hence, the risk of fiscal slippage will have a bearing on inflation outlook as well.
High core inflation and low output gap behind the unchanged policy stance:
The RBI’s decision to maintain status quo on the monetary policy stance as “calibrated tightening” reflects the central bank’s focus on core inflation along with real GDP growth near the full potential growth level. With this, we believe that the RBI has made a clear distinction between core inflation and headline inflation. So, while its near-term inflation projection is based on several transient and uncertain variables such as perishable food commodities and global crude prices, its policy signal is aligned with an upside risk to core inflation.
Banking sector measures did not offer much relief:
The RBI did not offer any relief on the LCR requirement by banks from Jan 1, 2019 (to be increased to 100% from the current 90%). The proposed SLR cut of 25bps every calendar year from the current 19.5% is part of the ongoing reform process. The announcement to link all floating rate personal loans and loans to MSMEs to a money market benchmark will enhance monetary policy transmission and will induce transparency in the lending-rate setting process of banks. The eventual impact of this on banks’ margins will depend on the awaited guidelines.
Policy outlook: status quo on both rates and stance:
In our view, the RBI will continue to maintain the “calibrated tightening” stance unless there are clear signs of an easing in core inflation. Given the scaling-down of near-term inflation projection, it is highly likely that the RBI will keep the policy rate unchanged in the next 3-4 months. The liquidity infusion to manage the domestic shortfall has been managed by active OMO purchases by the RBI (Rs1.36tn in FY19 YTD), and this route will continue to be maintained even in Q4FY19. From a market stand point, the expectation for a more accommodative view from the RBI, in line with the similar global view on the Fed rate trajectory, ended up in a disappointment ─ this explains the post-announcement volatility. The G-sec market reacted positively, with 10-yield declining further to 7.45%, which we believe, will also be transient.
Our sector stance for the banking sector is aligned with the prospects of an expected improvement in credit growth and earnings momentum leading to a further re-rating in select names. We continue to like private banks, with a preference toward the bell-weather HDFCB and also ICICI. We also like IndusInd Bank even as we expect Yes Bank to continue to lag. We remain underweight on PSU banks and the NBFC sector.
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