February 6, 2019 I Economics

Monetary Policy Review:

Meeting the market’s expectations and in line with CARE Ratings’
February 2020 expectations, the Monetary Policy Committee (MPC) maintained status
quo in its sixth bi-monthly monetary policy review, retaining the repo
rate unchanged at 5.15% while maintaining to stance at
‘accommodative’ citing the growth concerns while ensuring the
inflation remains within the RBI’s target range of 4% (+/- 2%). All
Contact: members voted in favour of the above decision.
Madan Sabnavis
Chief Economist The MPC stated that there still remains policy space for future actions.
Madan.sabnavis@careratings.com However, the outlook of inflation is uncertain with inflation expected to
+91-22- 6754 3404
be 5-5.4% in H1-FY21. For H1-FY21, the economic growth projections
have been revised downwards while the inflation projections have been
Author revised upwards even surpassing RBI’s inflation target of 4%.
Dr. Rucha Ranadive
Economist
rucha.ranadive@careratings.com
Key Highlights
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Table 1: Monetary policy rates

Mradul Mishra (Media Contact) % Oct’19 Dec’19 Feb’20 Change

mradul.mishra@careratings.com Repo rate 5.15 5.15 5.15
+91-22-6837 4424 Reverse repo 4.90 4.90 4.90
Marginal standing facility 5.40 5.40 5.40
Bank rate 5.40 5.40 5.40
Cash reserve ratio 4.00 4.00 4.00

RBI’s Assessment on global and domestic economy

A.
Disclaimer: This report is prepared by CARE Ratings Ltd.
CARE Ratings has taken utmost care to ensure accuracy and
objectivity while developing this report based on
information available in public domain. However, neither
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financial liability whatsoever to the user of this report
Global scenario
 Slow paced economic growth though getting
differentiated across geographies.
 Stable growth in the US with slack in consumer spending
though aided by government expenditure
 Slowdown in economic activities in Euro area amid
waning consumer confidence and tepid industrial
production and retail sales in the UK
 Weakness in the economic performance of emerging
markets hampered by sluggish domestic demand and
decline in industrial activities.
 Volatile crude oil prices - initial spike in prices led by US
Iran tension reverted post outbreak of coronavirus in
China raising demand concerns.
 Rising food prices globally
 Trend reversal from bullish sentiments in the early
January (US China trade deal and Brexit) to bearish
sentiments in the financial markets and softening yields
with concerns surrounding spread of coronavirus
 Economics I Monetary Policy Review: February 2020

 Strength in the US dollar

 Weakness in the EME currencies since the last week of January

B. Indian economy

Improvements since previous meeting Impediments since previous meeting

 Higher Rabi sowing
 Increase in production of vegetables
 Improved industrial activity
 Improved business expectations in Q4 FY20
indicated by pick up in PMI – manufacturing for
January
 Marginal improvement in services sectors – PMI –
services improved in January
 Signs of improvement in rural and urban demand
growth in sales of tractors, air traffic, three wheeler
and railway
 Persistent liquidity surplus in the banking system
 Softening 10 year benchmark GSec yields post
special OMOs
 Sizable transmission in the money market and
corporate bond market
 Increase in foreign investment flows – FDI and FPI
 Build up in forex
 Downward revision in GDP growth for FY19 from
6.8% to 6.1% and estimated 5% growth for FY20.
 Decline in GVA from 6% in FY19 to 4.9% in FY20
 Contraction in investment activity
 Notable decline in capacity utilisation (based on RBI
survey) from 73.6% in Q1 FY20 to 69.1% in Q2-FY20
 Weak demand conditions in the manufacturing in
Q3 FY20
 Surge in retail inflation owing to spike in food
inflation and modest uptick in core inflation
 Contraction in the exports and imports

RBI’s outlook on inflation and economic growth

Inflation

Owing to the various upside factors and increase in actual RBI’s inflation expectations in different policies
inflation overshooting projections, the inflation projections Period Oct’19 Dec’19 Feb’20
have been revised upwards. In Q4 FY20 and H1 FY21 the Q4 FY20 NA NA 6.5%
retail inflation is expected to surpass RBI’s inflation target H2FY20 3.5-3.7% 4.7-5.1% NA
at 4%. In fact for Q4 it is expected to overshoot RBI’s upper H1-FY21 NA 3.8-4% 5.4-5.0%
band of 6% of the inflation target. The factors guiding the Q3 FY21 NA NA 3.2%
inflation trajectory in the future are listed below.

Risks
 Pick up in prices of non-vegetable food items and
pulses due to shortfall in kharif production
 Volatile crude oil prices
 Increase in input cost for services
 Volatility in the domestic financial markets
 Increase in customs duties on items of retail
consumption leading to marginal one time pickup
in inflation
 Rise in food prices led by elevated vegetable prices
Positives
 Softening food inflation with arrival of late kharif
and rabi harvests
 Higher vegetable production
 Favourable base effect
 Pick-up in arrivals from the kharif season along
with Government measures to augment supply
through imports should aid soften vegetable prices
 Softening core inflation
 Range bound crude oil prices

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 Economics I Monetary Policy Review: February 2020

Risks Positives
 Incipient price pressures seen in other food items
to be sustained
 Higher inflation expectations
 Volatile financial markets

The MPC however points out that the inflation outlook remains highly uncertain on account of rise in non-food items, core
CPI due to increase in telecom charges, freight charges, prices of drugs and pharma and new emission norms. Higher
customs duties on some products would also affect core inflation.

Economic growth

Economic growth for FY21 has been pegged at 6% owing to expected recovery in the private consumption especially in
the rural areas aided by improved rabi prospects and recent rise in food prices, easing global trade uncertainties
encouraging exports and investment activity, progress in the monetary transmission, likely pick up in consumption and
investment demand, rationalisation of personal income tax might support the domestic demand along with measures to
boost rural and infra spending though a downside could emerge from outbreak of coronavirus in China impacting the
tourist arrivals and global trade.

Apr’19 Jun’19 Aug’19 Oct’19 Dec’19 Feb’20

FY20 7.2% 7% 6.9% 6.1% 5%
H2FY20 7.3-7.4% 7.2-7.5% 7.3-7.5% 6.6-7.2% 4.9-5.5%
Q1 FY21 7.4% 7.2% NA
H1-FY21 NA NA NA NA 5.9-6.3% 5.5-6%
Q3 FY21 6.2%
FY21 6%

Developmental and regulatory policies

 Revision in Liquidity management framework

o Operating target weighted average call rate (WACR)
o Width of the corridor remains unchanged at 50 basis points
o Abolishing the need for specifying a one-sided target for liquidity provision of one percent of net demand and time
liabilities (NDTL)
o Withdrawal of daily fixed rate repo and four 14 day term repo while ensuring adequate provision/absorption of
liquidity using fixed and variable rate repo/reverse repo auctions, outright open market operations (OMOs), forex
swaps and other instruments
o Main liquidity management tool: A 14-day term repo/reverse repo operation at a variable rate
o Longer-term variable rate repo/reverse repo operations of more than 14 days if the need arises

Impact
The WACR will have to be monitored to gauge the extent of support to be received from the RBI. This can be through
daily or term repo as and when required. The removal of the 1% NDTL limit would work well for banks which require
more funding in times of liquidity shortage.

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 Economics I Monetary Policy Review: February 2020

 Long Term Repo Operations (LTROs) for Improving Monetary Transmission

o Term repo of 1 year and 3 year tenures of appropriate sizes for up to a total amount of Rs 1,00,000 crore at the
policy repo rate fortnightly beginning on February 15, 2020
Impact
The use of these instruments will depend on a series of factors. First, the banks would look at their cost of funds.
Presently the weighted cost of deposits is between 4.8-5% which makes the repo rate seem high from the point of view
of taking a long term call of above 1 year. Second, the overall state of liquidity will also be of importance as there are
options of going in for shorter term repos to source funding. Third, the expectations of the future are also important. In
case rates are expected to come down, banks may not like to lock-in a higher repo rate.

 Incentivising Bank Credit to Specific Sectors

o Scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as
retail loans for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs) over
and above o/s as on January 31, 2020 from NDTL and CRR maintenance up to July 31, 2020.
Impact
While this will be beneficial to banks which can be incentivized to lend more to these sectors, the present state of
excess liquidity may not really warrant such action on a large scale. However, to the extent that resources are freed
from CRR they can be invested even in the reverse repo auctions at the limit to accrue a net gain.

 External Benchmarking of New Floating Rate Loans by Banks to Medium Enterprises

o Pricing of loans by scheduled commercial banks for the medium enterprises also to an external benchmark
effective April 1, 2020
Impact
This will be useful for medium enterprises which can get loans at rates closer to the benchmark. However it needs to be
seen whether or not banks change the spread charged on this benchmark for various enterprises under this category.

 Extension of One-time Restructuring Scheme for MSME advances till December 31, 2020
This gives MSMEs some more time to recoup from the problems that they have been facing so far. The various
measures announced by the government and this step taken by the RBI will make them more viable.

 Projects under Implementation in Commercial Real Estate sector

o Permit extension of date of commencement of commercial operations (DCCO) of project loans for commercial real
estate, delayed for reasons beyond the control of promoters, by another one year without downgrading the asset
classification
Impact
This can be taken to be a logical corollary of steps being taken by the RBI against the initiatives taken by the
government by setting up the Rs 25,000 cr fund to help developers. This will be beneficial for both banks and
borrowers.

 RRBs to act as merchant acquiring banks, using Aadhaar Pay – BHIM app and POS terminals
 Proposed that all rupee IRD transactions of market makers and their related entities globally, shall be accounted for in
India to deepen Rupee Interest Rate Derivative Market
 Construct and periodically publish a composite “Digital Payments Index” (DPI) and consider establishing an Self-
Regulatory Organisation SRO for the digital payment system by April 2020

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 Economics I Monetary Policy Review: February 2020

CARE Ratings’ View

The RBI has indicated that there could be rate cuts going ahead but would be data dependent. In the April policy going by
the RBI’s forecast inflation would still be high at 5.45% and may not merit this move. It is more likely this would be in course
of the year as inflation numbers become more favourable. The growth projection for next year is similar to what the Budget
and Economic Survey have spoken of; but one may have to wait for the second half to see a more prominent push to
growth. We could expect another 25-50 bps rate cut during the course of FY21 which however will be data dependent.

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