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The Monetary Policy Committee (MPC) today voted 4-2 in favour of cutting the policy repo rate by 25bps to 6.00%. Further, 5 members voted in favour of maintaining the policy stance at “neutral”, while one voted for changing it to “accommodative”. The reverse repo rate now stands at 5.75% and the cash reserve ratio (CRR) remains unchanged at 4.0%.
In other measures, RBI decided to permit banks an additional carve out of 2% of their Net demand and Term Liabilities (NDTL) from Statutory Liquidity Ratio (SLR) holdings, in a phased manner over one year, for the purpose of computing their Liquidity coverage ratio (LCR).
RBI lowered its inflation projections to 2.4% for Q4 FY19 (from 2.8% earlier), 2.9-3.0% in H1FY20 and 3.5-3.8% in H2 FY20 (from 3.2-3.4% in H1FY20 and 3.9% in Q3 FY20) with risks broadly balanced. According to RBI, assuming normal monsoon, headline inflation is expected to remain soft in the near term primarily on account of (1) weak food inflation, (2) fall in household inflation expectations and (3) moderating impact of lower than expected core inflation. Further, oil prices have inched up recently but outlook is uncertain due to production cuts by OPEC partly negated by concerns over global demand.
RBI also revised down the growth outlook to 7.2% for FY 20 with 6.8-7.1% in H1FY20 and 7.3-7.4% in H2 FY20 (as against earlier estimate of 7.2-7.4% in H1 and 7.5% in Q3 FY20). RBI acknowledged that economic activity in domestic economy is moderating and growth is facing resistance, particularly due to global growth concerns. Further, volatility in global financial markets, trade tensions and geopolitical uncertainties could adversely impact growth prospects.
As per RBI, investment activity is recovering but is supported mainly by government push on roads and affordable housing. Private consumption is stable and likely to strengthen due to focus on public spending in rural areas and tax benefits announced in budget. RBI acknowledged the need to improve private sector investment activity, which has been lagging. Against this backdrop, the MPC decided to reduce the policy repo rate by 25 bps while maintaining the stance of monetary policy at neutral.
Conclusion and Outlook
The MPC’s decision to reduce policy rate by 25bps was in line with market expectations. Given the near term inflation outlook remains benign and growth is moderating, it could provide some space for further policy easing. However, any future action by RBI is likely to be data dependent and we maintain that this rate cut cycle is likely to be a shallow one, in our opinion.
By further increasing the carve out from mandated SLR for the purpose of LCR calculations by 2%, RBI has improved banks’ flexibility to provide credit. However, on the flip side, demand for the dated Gsec will be adversely impacted as it further increases the already excess SLR holdings of banks, especially PSU banks.
Large increase in gross market borrowings in FY20 over FY19 along with low demand for government bonds due to excess SLR in the banking system could put upward pressure on yields. Even though the near term inflation outlook remains benign due to low food prices and range bound oil prices, we prefer to maintain a cautious stance. This is due to a modest uptick in growth expected in FY20, credit growth outpacing deposit growth and likely fiscal pressures.
In view of the above, the short to medium end of the yield curve continues to offer better risk adjusted returns than the long end. Hence, we continue to recommend investment in short to medium duration debt funds.
In other measures, RBI decided to permit banks an additional carve out of 2% of their Net demand and Term Liabilities (NDTL) from Statutory Liquidity Ratio (SLR) holdings, in a phased manner over one year, for the purpose of computing their Liquidity coverage ratio (LCR).
RBI lowered its inflation projections to 2.4% for Q4 FY19 (from 2.8% earlier), 2.9-3.0% in H1FY20 and 3.5-3.8% in H2 FY20 (from 3.2-3.4% in H1FY20 and 3.9% in Q3 FY20) with risks broadly balanced. According to RBI, assuming normal monsoon, headline inflation is expected to remain soft in the near term primarily on account of (1) weak food inflation, (2) fall in household inflation expectations and (3) moderating impact of lower than expected core inflation. Further, oil prices have inched up recently but outlook is uncertain due to production cuts by OPEC partly negated by concerns over global demand.
RBI also revised down the growth outlook to 7.2% for FY 20 with 6.8-7.1% in H1FY20 and 7.3-7.4% in H2 FY20 (as against earlier estimate of 7.2-7.4% in H1 and 7.5% in Q3 FY20). RBI acknowledged that economic activity in domestic economy is moderating and growth is facing resistance, particularly due to global growth concerns. Further, volatility in global financial markets, trade tensions and geopolitical uncertainties could adversely impact growth prospects.
As per RBI, investment activity is recovering but is supported mainly by government push on roads and affordable housing. Private consumption is stable and likely to strengthen due to focus on public spending in rural areas and tax benefits announced in budget. RBI acknowledged the need to improve private sector investment activity, which has been lagging. Against this backdrop, the MPC decided to reduce the policy repo rate by 25 bps while maintaining the stance of monetary policy at neutral.
Conclusion and Outlook
The MPC’s decision to reduce policy rate by 25bps was in line with market expectations. Given the near term inflation outlook remains benign and growth is moderating, it could provide some space for further policy easing. However, any future action by RBI is likely to be data dependent and we maintain that this rate cut cycle is likely to be a shallow one, in our opinion.
By further increasing the carve out from mandated SLR for the purpose of LCR calculations by 2%, RBI has improved banks’ flexibility to provide credit. However, on the flip side, demand for the dated Gsec will be adversely impacted as it further increases the already excess SLR holdings of banks, especially PSU banks.
Large increase in gross market borrowings in FY20 over FY19 along with low demand for government bonds due to excess SLR in the banking system could put upward pressure on yields. Even though the near term inflation outlook remains benign due to low food prices and range bound oil prices, we prefer to maintain a cautious stance. This is due to a modest uptick in growth expected in FY20, credit growth outpacing deposit growth and likely fiscal pressures.
In view of the above, the short to medium end of the yield curve continues to offer better risk adjusted returns than the long end. Hence, we continue to recommend investment in short to medium duration debt funds.
