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Monetary Policy Update

Oct 5, 2017

Repo Rate Maintained at 6%, Policy Tone Remains Neutral

The Reserve Bank of India today decided to keep the policy repo rate unchanged at 6% in an “effective” 5-to-1 vote. 5 voted for status quo, while Dr. Ravindra Dholakia voted for a 25bps cut.

The Monetary Policy Committee maintained its neutral stance on monetary policy and achieving a medium-term target for CPI of 4% ± 2%, while supporting growth.

Statutory Liquidity Ratio (SLR) was cut by 50bps to 19.5% from the fortnight commencing 14-Oct-17.

Key highlights

Domestic Macro Conditions Mixed

The slowdown that has been evident since the last quarter of 2016 has continued into the current period. Improvement in services is likely to balance persistent weakness in industrial production. Inflation appears to have hit a cyclical low in June and global trends in crude and commodities suggest that a rising trajectory in prices is likely for the rest of the year.

Further, the distribution of the monsoon has been uneven and deficient, leading to an expected decline in kharif output. The dollar strengthening is a further contributor to likely upticks in fuel inflation.

Despite extensive front-loading of expenditure by the central government, economic output has decelerated. IIP recovered marginally in Jul-17 on the back of a recovery in mining, quarrying and electricity generation; however, manufacturing remains weak.

Implementation of GST appears to have had an adverse impact on prospects for the manufacturing sector. However, core industries posted robust growth in Aug-17 of roughly 4%, which paints to an improving picture.

Strengthening Developed Economies and Emerging Economies

The U.S. has continued to expand with revised Q2 GDP growing at its strongest pace in more than two years. Growth has been supported by robust consumer spending and business fixed investment, though focus remains on the hawkish U.S. Fed stance.

The Euro area has also showed strong health with purchasing managers’ index (PMI) for manufacturing soaring to its highest reading in more than six years. Here as well, the risk of normalisation by the European Central Bank remains.

In the emerging economies, strong growth in Q2 in China was powered by retail sales, and imports, suggesting robust domestic demand; though investment activity slowed down. Brazil expanded for two consecutive quarters in Q2 on improving terms of trade, even as the impact of recession persists on the labour market. Russia recovered further, supported by strengthening global demand, firming up of oil prices and accommodative monetary policy.

Inflation Remains Elevated

CPI inflation has picked up coming in at 3.36% in Aug-17 (a five-month high) driven by a rebound in vegetable prices, meals, and fruits as well as hardening of petroleum prices tracking rising international crude oil prices. In light of this, the excise duty cut of Rs. 2 on fuels should help mitigate the impact of increasing global fuel prices on domestic consumers. The concern, however, remains on fiscal slippages as a result of farm loan waivers and excise duty cuts.

Quantitative inflation expectations of households eased in the Sep-17 round of the Reserve Bank’s survey. However, in terms of qualitative responses, the proportion of respondents expecting the general price level to increase by more than the current rate rose markedly for the three-month as well as one-year ahead horizons.

Market Reactions

Ten-year yields increased to 6.69% by the close of day from 6.62% with upward volatility immediately post the RBI release. Rising ten year yields were driven higher on the back of RBI’s expectations of firming inflation, as well as the potential rising borrowing needs of the government.

Even as bonds sold off, the benchmark NIFTY50 index closed up +0.2% and the INR strengthened +0.5%, with the market choosing to take comfort in a mixed set of data that suggests that the economy is not in as bad a shape as is being feared.


In its last meeting in Aug-17, the MPC had projected 3% inflation in Q2 and 4-4.5% in H2FY18. However, firming food prices, price revisions due to GST, increase in CPI ex food and fuel, and sustained firming of international crude oil prices contributed towards the MPC’s current increased estimate of 4.2-4.6% in H2FY18.

GST’s impact on manufacturing further hampered by stressed balance sheets of banks and corporates has resulted in the RBI lowering their real GVA growth forecast for FY18 to 6.7% (vs. 7.3% in Aug-17 meeting).

The RBI maintained that it intends to remain watchful of fiscal slippages and that it is imperative to reinvigorate investment activity which, in turn, would revive the demand for bank credit by industry.

The next meeting of the MPC is scheduled on 06-Dec-17.

We expect the RBI’s preference to keep a tab on fiscal discipline and its decision to maintain status quo should bode well for the economy as much of the initiatives undertaken by the government to bolster growth should come through in the long run.