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RBI shifts policy stance from accommodative to neutral on fear of
inflation
The Monetary
Policy Committee in its first Bi-Monthly Monetary Policy review, held on 6 th
April 2017, kept the borrowing rates unchanged at 6.25 percent. The committee
however hiked reverse repo rate by 25 basis points to 6 percent in a bid to
drain excess liquidity from the system. Speaking about liquidity, there was
approximately Rs. 7,956 billion of excess cash in the banking system in
January’17 which now stands close to Rs. 4,806 billion (March’17). This decline
was majorly due to RBI’s tooling i.e. Market Stabilization Scheme which helped
the central bank to absorb excess cash of around Rs. 3,141 billion by the end
of March’17.
According to
the RBI staff projections, the inflation rate which currently is at 3.65
percent is projected to rise at 4.5 percent in the first half of 2017-18 and
thereafter at 5 percent. Reason behind this upsurge in consumer prices could be
attributed to the rising probability of an El Niño event which could boost food
inflation. Implementation of 7 th Pay Commission and GST bill along with global
developments are other factors for the inflation uptick.
With respect
to economic growth, gross value added growth is projected to strengthen to 7.4
percent in 2017-18 from 6.7 percent in 2016-17 primarily due to - rebound in
consumer spending, credit growth, recent proposals in the Union Budget which
could stimulate capital expenditure, roll-out of GST bill and the upsurge in
IPO’s which augurs well for investment and growth.
Inflationary pressure to re-emerge along with higher growth
MPC clearly
spells out higher upside risks to inflation. Average CPI is projected to be higher
at 4.5% in H1FY18, currently at 3.7% in Feb’17, to 5.0% in H2FY18. Currently,
demonetization spillovers has suppressed the headline inflation numbers.
Headline inflation is likely to edge higher as the temporary impact of
demonetization on perishable food items fades out and core inflation (4.8% YoY
in Feb’17) inches up along with cyclical upswing in demand. The factors that
are expected to reinforce inflationary pressure include
a) deficient
south west monsoon & higher MSPs reinforcing food inflation,
b) increase
in HRA as recommended by 7th pay commission is likely to push baseline
inflation trajectory by 100-150bps,
c) initial
effect from implementation of GST,
d) farm loan
waivers by state governments,
e) policy
focus to revive demand particularly from increase in budget allocation towards
rural & affordable housing,
f) narrowing
of output gap as remonetisation progresses,
g) spillover
of improving global prospects on commodity prices,
h) rising
inflation in advance economies due to reflationary policies,
i) currency
impact arising from normalization of monetary policy in advance economies,
especially US Fed and
j)
protectionism policies adopted across the world.
On growth
front (real GVA), the outlook is seen favorable at 7.4% vs 6.7% on the back of
a)
gainingremonetisation,
b)
reflationary fiscal policies, specially targeted towards rural demand and
c) cyclical
upturn in global growth.
According to
the RBI governor, global trade volumes are finally improving which means that
global demand is no more anaemic in nature. The world’s largest economy i.e.
the United States of America is on growth path since all its important economic
datasets on labour market, inflation and growth have come on a positive note.
However, there is uncertainty surrounding the direction of US macro-economic
policies with potential global spill over. The governor also feels that
emerging markets are gradually improving on hardening commodity prices, easing
recessionary pressures in Russia/Brazil and stabilized Chinese policy stimulus.
Overview of
Indian economy
The
demonetization effect on the economy is finally easing. This can be observed
from the rebound seen in manufacturing and service PMI data since
demonetization. Both the PMI data lingered close to 49.6 and 46.8 in
December’16 and has finally increased to 52.5 and 51.5 respectively in March’17
due to pickup seen in demand for new orders and output. This has benefitted the
Index of industrial production (IIP) data which surged to 2.7 percent in
January’17 from previous months -0.1 percent. Overall business sentiment is
expected to improve in Q1 of 2017-18 on the back of a sharp pick up in both
domestic and external demand y | June 7, 2016 www.angelcommodities.com
Page 2 RBI Monetary Policy Update 06 April 2017 About the inflation rate, since
the last two months the consumer prices have been increasing, all thanks to
increase in the prices of sugar, fruits, meat, fish, milk and processed foods.
Kerosene prices have also been increasing on the back of reduction in
subsidies. With respect to balance of trade, India’s trade deficit narrowed to
$8.9 billion in Feb-17 from previous month’s deficit of $9.8 billion due to
lower crude oil prices. The above strong macro-economic datasets along with the
resounding win of BJP party in Uttar Pradesh elections along with the clearance
of GST bill in the LokSabha has led to a sudden surge in inflows which has
acted as a positive factor both for Indian markets and its currency. The annual
growth rate which was at 7.4 percent in September’16 quarter expanded by mere 7
percent owing to the demonetization move. The Monetary Policy Committee expects
economic activities to recover in the second half of 2017-18.
Summing up
The
no-change-in-policy was mainly undertaken to guard the Indian economy against
any potential flare-up in inflation. Post this event, the Indian Rupee spot has
been continuously appreciating and is currently trading at 64.51 levels while
writing. USDINR spot is likely to appreciate even more in the near term as
uncertainty with respect to Trump’s fiscal policies will keep the American
currency pressurized in turn favouring the Indian currency
Liquidity to
normalize by Q2FY18 RBI’s has reinforced its earlier outlook of re-emergence of
inflationary pressure with a mild hawkish overtone. Hence, even the marginal
market expectation of rate easing and softening of Gsec yields has been ruled
out. The pace of remonetisation will provide reinforcement to domestic demand
and growth outlook. Our projections indicate that complete normalization of
demonetization, including reprinting of notes and meeting normalized demand
will be achieved by end of Q1FY18, i.e. eight months post demonetization
announcement. Expected upside risk to inflation can enhance the hawkish tenor
of the RBI’s monetary policy stance. Additionally, prospects of rising global
rates led by the Fed’s normalization will condition RBI’s policy outlook, in
our view.