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#39;RBI#39;s dovish outlook will boost consumption ahead of Lok Sabha polls#39;

February 11
11:29 2019

Dhananjay Sinha

The six-member Monetary Policy Committee (MPC), headed by newly appointed RBI governor Shaktikanta Das, tweaked its policy stance to ‘neutral’ from ‘calibrated tightening’. We believe that the current situation opens the scope for more rate cuts in 2019.

The central bank, in its sixth bi-monthly meeting on February 7, took a U-turn and surprised the market stakeholders by announcing a 25bps cut in the benchmark interest rate with immediate effect, which now stands at 6.25 percent.

The shift in its stance to ‘neutral’ was broadly in line with consensus expectations, however, the rate cut was somewhat unexpected. Last time, the apex bank cut rates in August 2017.

We feel that the decision to cut repo rate has been justified on grounds of a sharp cut in projected headline inflation by the RBI. We think that the combination of a reflationary budget presented on February 1 along with the monetary easing by the RBI will give a further boost to consumption in the country ahead of Lok Sabha polls.

In other announcements, CPI inflation has been revised to 2.8 percent for Q4FY19, 3.9 percent in Q3FY20 and 3.2-3.4 percent for the first half of FY20. Headline inflation is projected to remain soft in the near term. We believe that the implication for inflation is somewhat on the higher side. The central bank may have taken a benign view in this regard.

Core inflation remains high, which averages at 6 percent over the last six months. This is significantly higher than non-core components, which was -1.4 percent in December 2018. With the RBI MPC’s decision significantly aligned to the headline inflation, the decision incorporates a larger influence of the non-core inflation. In our view, the combination of fiscal expansion and rate cuts will bring on an upside risk to core inflation over the medium term.

In today’s meeting, the RBI has also raised the limit for collateral free farm loans to Rs 1,60,000 from the earlier Rs 1,00,000. This is aligned with the big fiscal boost provided to the agri sector in the recently announced interim budget. One can expect a stronger push on banks to accommodate larger farm loan waivers and an enlargement in credit risk on farm loan portfolio.

The RBI has also further relaxed the ECB norms for corporates, wherein they can borrow up to $ 750 million through the automatic route without the restriction of end-use to repay existing rupee loans. This is being done to relax the funding pressure arising from the tightening credit conditions in the domestic market. This becomes relevant especially in the context of funding constraints faced by NBFCs and companies undergoing insolvency and bankruptcy process.

This measure can provide a short-term respite to the BFSI sector and also to stressed corporates. However, this will also expose Indian corporates to currency risks, going forward, even as it fails to address the core credit risk issue.

The author is Head-Institutional Research, Economist and Strategist, Emkay Global Financial Services.

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