The decision of the MPC is consistent with a neutral
stance of monetary policy in consonance with the objective of achieving the
medium-term target for consumer price index (CPI) inflation of 4% within a band
of +/- 2%, while supporting growth.
Assessment
Global economic activity has
shown increasing signs of weakness on rising trade tensions. Among advanced
economies (AEs), economic activity appears to be slowing in the US in Q4:2018,
after a buoyant Q3. The Euro area growth lost pace in Q3, impacted by weaker
trade growth and new vehicle emission standards. The Japanese economy
contracted in Q3 on subdued external and domestic demand. Economic activity
also decelerated in major emerging market economies (EMEs) in Q3. In China, growth
slowed down on weak domestic demand. The ongoing trade tensions and the
possible cooling of the housing market pose major risks to growth in China. The
Russian economy lost some traction, pulled down largely by a weak agriculture
harvest, though the growth was buttressed by strong performance of the energy
sector. The Brazilian economy seems to be recovering gradually from the
economic disruption in the first half of the year.
Crude oil
prices have declined sharply, reflecting higher supplies and easing of
geo-political tensions. The inflation scenario has remained broadly unchanged
in the US and the Euro area. In many key EMEs, however, inflation has risen,
though the recent retreat in energy prices, tightening of policy stances by
central banks and stabilising of currencies may have a salutary impact, going
forward.
Global financial markets have
been driven mainly by rising policy rates in the US, volatile crude oil prices
and expectations of a slowdown compared with earlier projections. Among AEs,
equity markets in the US witnessed a selloff on the weakening outlook for
corporate earnings caused by rising borrowing costs, while the European stock
markets declined on political uncertainties. The Japanese stock market also
shed gains on global cues and the gradual strengthening of the yen. EM stock
markets have corrected on shrinking global liquidity, weak economic data in
some key EMEs, and lingering trade tensions. The 10-year yield in the US, which
surged on robust economic data at the beginning of October, softened
subsequently on the unchanged Fed stance. Among other AEs, bond yields in the
Euro area and Japan softened on weak economic sentiment and idiosyncratic
factors. In most EMEs, bond yields have softened in recent weeks on falling
crude oil prices and steadying currencies. In currency markets, the US dollar,
which was strengthening on a widening growth differential with its peers, eased
in the second half of November. The euro has weakened on Brexit and budget
concerns in Italy, while the yen appreciated on safe haven buying in November.
EME currencies have been trading with an appreciating bias, supported by a
sharp decline in crude oil prices and conservative domestic monetary policy
stances.
In India GDP growth slowed down to 7.1 per cent
year-on-year (y-o-y) in Q2:2018-19, after four consecutive quarters of
acceleration, weighed down by moderation in private consumption and a large
drag from net exports. Private consumption slowed down possibly on account of
moderation in rural demand, subdued growth in kharif output, depressed prices
of agricultural commodities and sluggish growth in rural wages. However, growth
in government final consumption expenditure (GFCE) strengthened, buoyed by
higher spending by the central government. Gross fixed capital formation (GFCF)
expanded by double-digits for the third consecutive quarter, driven mainly by
the public sector’s thrust on national highways and rural infrastructure, which
was also reflected in robust growth in cement production and steel consumption.
Growth of imports accelerated at a much faster pace than that of exports,
resulting in net exports pulling down aggregate demand.
On the supply
side, growth of gross value added (GVA) at basic prices decelerated to 6.9 per
cent in Q2, reflecting moderation in agricultural and industrial activities.
Slowdown in agricultural GVA was largely the outcome of tepid growth in kharif
production. Within industry, growth in manufacturing decelerated due to lower
profitability of manufacturing firms, pulled down largely by a rise in input
costs, while that in mining and quarrying turned negative, caused by a
contraction in output of crude oil and natural gas. Growth in electricity, gas,
water supply and other utility services strengthened. Services sector growth
remained unchanged at the previous quarter’s level. Of its constituents, growth
in construction activity decelerated sequentially, but it was much higher on a
y-o-y basis. Growth in public administration and defence services accelerated
sharply.
The purchasing managers’ index
(PMI) for manufacturing touched an eleven-month high of 54.0 in November,
supported by an expansion in output, and domestic and export orders. According
to the assessment of the Reserve Bank’s Industrial Outlook Survey (IOS), the
overall business sentiment in Q3 remained stable, with sustained optimism about
production and exports.
Retail inflation, declined from 3.7
per cent in September to 3.3 per cent in October. A large fall in food prices
pushed food group into deflation and more than offset the increase in inflation
in items excluding food and fuel. Adjusting for the estimated impact of an
increase in HRA for central government employees, headline inflation was 3.1
per cent in October. Within the food and beverages group, deflation in
vegetables, pulses and sugar deepened in October. Inflation, however, showed an
uptick in meat and fish, and non-alcoholic beverages. Inflation in the fuel and
light group remained elevated, driven by LPG prices in October, tracking
international petroleum product prices. However, electricity prices softened in
October. Inflation in rural fuel items also moderated. CPI inflation excluding
food and fuel accelerated to 6.1 per cent in October; adjusted for the
estimated HRA impact, it was 5.9 per cent. Transport and communication
registered a marked increase, pulled up by higher petroleum product prices,
transportation fares and prices of automobiles. A broad-based increase was also
observed in health, household goods and services, and personal care and
effects. However, inflation moderated significantly in clothing and footwear,
as also housing on waning of the HRA impact of central government employees.
Inflation
expectations of households, measured by the November 2018 round of the Reserve
Bank’s survey, softened by 40 basis points for the three-month ahead horizon
over the last round reflecting decline in food and petroleum product prices,
while they remained unchanged for the twelve-month ahead horizon. Producers’
assessment for input prices inflation eased marginally in Q3 as reported by
manufacturing firms polled by the Reserve Bank’s IOS. Domestic farm and
industrial input costs remained high. Rural wage growth remained muted in Q2,
while staff cost growth in the manufacturing sector remained elevated.
Liquidity needs arising from the growth
in currency and the Reserve Bank’s forex operations were met through a mixture
of tools based on an assessment of the evolving liquidity conditions. The
Reserve Bank injected durable liquidity amounting to Rs. 360 billion in October
and Rs. 500 billion in November through open market purchase operations,
bringing total durable liquidity injection to Rs. 1.36 trillion for 2018-19.
Liquidity injected under the LAF, on an average daily net basis, was Rs. 560
billion in October, Rs. 806 billion in November. The WACR traded below the repo
rate on an average by 5 basis points in October and 9 basis points in November.
There was large currency expansion in October and especially during the festive
season in November. Currency in circulation, however, contracted in each of the
last three weeks in November.
Merchandise exports rebounded in October 2018,
after moderating in the previous month, driven mainly by petroleum products,
engineering goods, chemicals, electronics, readymade garments, and gems and
jewellery. Imports also grew at a faster pace in
October relative to the previous month, contributed mainly by petroleum
products and electronic goods. Consequently, the trade deficit widened in October, sequentially,
as also in comparison with the level a year ago. Provisional data suggest a
modest improvement in net exports of services in Q2:2018-19, which augurs well
for the current account
balance. On
the financing side, net FDI flows moderated in April-September
2018. Portfolio flows turned positive in November on
account of a sharp decline in oil prices, indications of a less hawkish stance
by the US Fed and a softer US dollar. However, during the year, there were net
portfolio outflows of US$14.8 billion (up to November 30). Non-resident
deposits increased markedly in H1:2018-19 on a net basis over their level a
year ago. India’s foreign
exchange reserves were at US$393.7 billion on November 30, 2018.
Outlook
GDP growth outlook for 2018-19 has been projected at 7.4 per cent
(7.2-7.3 per cent in H2) as in the October policy, and for H1:2019-20 at 7.5
per cent, with risks somewhat to the downside. Although Q2 growth was lower
than that projected in the October policy, GDP growth in H1 has been broadly along
the line in the April policy when for the year as a whole GDP growth was
projected at 7.4 per cent. Going forward, lower rabi sowing may adversely
affect agriculture and hence rural demand. Financial market volatility, slowing
global demand and rising trade tensions pose negative risk to exports. However,
on the positive side, the decline in crude oil prices is expected to boost
India’s growth prospects by improving corporate earnings and raising private
consumption through higher disposable incomes. Increased capacity utilisation
in the manufacturing sector also portends well for new capacity additions.
There has been significant acceleration in investment activity and high
frequency indicators suggest that it is likely to be sustained. Credit offtake
from the banking sector has continued to strengthen even as global financial
conditions have tightened. FDI flows could also increase with the improving
prospects of the external sector. The demand outlook as reported by firms
polled in the Reserve Bank’s IOS has improved in Q4.
Headline inflation outlook is driven primarily by several factors. First,
despite a significant scaling down of inflation projections in the October
policy primarily due to moderation in food inflation, subsequent readings have continued
to surprise on the downside with the food group slipping into
deflation. The broad-based weakening of food prices imparts downward bias
to the headline inflation trajectory, going forward. Secondly, in contrast to
the food group, there has been a broad-based increase in inflation in non-food
groups. Thirdly, international crude oil prices have declined sharply since the
last policy; the price of Indian crude basket collapsed to below US$60 a barrel
by end-November after touching US$85 a barrel in early October. However,
selling prices, as reported by firms polled in the Reserve Bank’s latest IOS,
are expected to edge up further in Q4 on the back of increased demand.
Fourthly, global financial markets have continued to be volatile with EME
currencies showing a somewhat appreciating bias in the last one month. Finally,
the effect of the 7th Central Pay Commission’s HRA increase has continued to
wane along expected lines. Taking all these factors into consideration and
assuming a normal monsoon in 2019, inflation is projected at 2.7-3.2 per cent
in H2:2018-19 and 3.8-4.2 per cent in H1:2019-20, with risks tilted to the
upside.
Several uncertainties still
cloud the inflation outlook. First, inflation projections incorporate benign
food prices based on the realised outcomes of food inflation in recent months.
The prices of several food items are at unusually low levels and there is a
risk of sudden reversal, especially of volatile perishable items. Second,
uncertainty continues about the exact impact of MSP on inflation, going
forward. Third, the medium-term outlook for crude oil prices is still uncertain
due to global demand conditions, geo-political tensions and decision of OPEC
which could impinge on supplies. Fourth, global financial markets continue to
be volatile. Fifth, though households’ near-term inflation expectations have
moderated in the latest round of the Reserve Bank’s survey, one-year ahead
expectations remain elevated and unchanged. Sixth, fiscal slippages, if any, at
the centre/state levels, will influence the inflation outlook, heighten market
volatility and crowd out private investment. Finally, the staggered impact of
HRA revision by State Governments may push up headline inflation.
Developmental and Regulatory Policies
External Benchmarking of New Floating Rate Loans by Banks
It is proposed that all new floating rate personal
or retail loans (housing, auto, etc.) and floating rate loans to Micro and
Small Enterprises extended by banks from April 1, 2019 shall be
benchmarked to one of the following:
- Reserve Bank of India
policy repo rate, or
- Government of India 91
days Treasury Bill yield produced by the Financial Benchmarks India Private Ltd
(FBIL), or
- Government of India 182
days Treasury Bill yield produced by the FBIL, or
- Any other benchmark market
interest rate produced by the FBIL.
The spread over the
benchmark rate — to be decided wholly at banks’ discretion at the inception of
the loan — should remain unchanged through the life of the loan, unless the
borrower’s credit assessment undergoes a substantial change and as agreed upon
in the loan contract. Banks are free to offer such external benchmark linked
loans to other types of borrowers as well. In order to ensure transparency,
standardisation, and ease of understanding of loan products by borrowers, a
bank must adopt a uniform external benchmark within a loan category.
Aligning
Statutory Liquidity Ratio with Liquidity Coverage Ratio
As per the
existing roadmap, scheduled commercial banks have to reach the minimum Liquidity
Coverage Ratio (LCR) of 100 per cent by January 1, 2019. Presently, Statutory
Liquidity Ratio (SLR) is 19.5 per cent of Net Demand and Time Liabilities
(NDTL). Further, the assets allowed to be reckoned as Level 1 High Quality
Liquid Assets (HQLAs) for the purpose of computing the LCR of banks, inter
alia, include (a) Government securities in excess of the minimum SLR
requirement; and (b) within the mandatory SLR requirement, Government
securities to the extent allowed by RBI under (i) Marginal Standing Facility
(MSF) [presently 2 per cent of the bank's NDTL] and (ii) Facility to Avail
Liquidity for Liquidity Coverage Ratio (FALLCR) [presently 13 per cent of the
bank's NDTL]. In order to align the SLR with the LCR requirement, it is
proposed to reduce the SLR by 25 basis points every calendar quarter until the
SLR reaches 18 per cent of NDTL.
Financial Markets
Access
for Non-Residents to the Interest Rate Derivatives Market
The
draft directions in this regard propose allowing non-residents to hedge their
rupee interest rate risk flexibly using any available IRD instrument.
Non-residents will also be permitted to participate in the Overnight Indexed
Swap (OIS) market for non-hedging purposes, subject to a macro-prudential limit
on exposure of all non-residents in terms of the interest rate risk undertaken.
Measures
to Improve Liquidity Management by Banks
In order to enable banks to forecast their liquidity requirements with a
greater degree of precision, it has been decided that the Reserve Bank will
provide information on daily CRR balance of the banking system to market
participants on the very next day. Accordingly, the daily Money Market
Operations press release will contain the CRR figure for the previous day.
Rationalisation
of Borrowing and Lending Regulations under FEMA, 1999
As part of the
ongoing efforts at rationalising multiple regulations framed over a period of
time under FEMA, 1999, it is proposed to consolidate the regulations governing
all types of borrowing and lending transactions between a person resident in
India and a person resident outside India in both foreign currency and INR, in
consultation with the Government. The proposed regulations, viz., Foreign
Exchange Management (Borrowing or Lending) Regulations, 2018 shall subsume the
existing ones and rationalise the extant framework for external commercial
borrowings and Rupee denominated bonds with a view to improving the ease of
doing business.
Customer Education, Protection
and Financial Inclusion
Ombudsman
Scheme for Digital Transactions
With the digital
mode for financial transactions gaining traction in the country, there is an
emerging need for a dedicated, cost-free and expeditious grievance redressal
mechanism for strengthening consumer confidence in this channel. It has
therefore been decided to implement an ‘Ombudsman Scheme for Digital
Transactions’ covering services provided by entities falling under Reserve
Bank’s regulatory jurisdiction.
Framework
for Limiting Customer Liability in respect of Unauthorised Electronic Payment
Transactions
The Reserve Bank
has issued instructions on limiting customer liability in respect of
unauthorised electronic transactions involving banks and credit card issuing
non-banking financial companies (NBFCs). As a measure of consumer protection,
it has been decided to bring all customers up to the same level with regard to
electronic transactions made by them and extend the benefit of limiting
customer liability for unauthorised electronic transactions involving Prepaid
Payment Instruments (PPIs) issued by other entities not covered by the extant
guidelines.
Expert
Committee on Micro, Small and Medium Enterprises
An Expert
Committee will be constituted by the Reserve Bank of India to identify causes
and propose long-term solutions for the economic and financial sustainability
of the MSME sector.
