Monday, February 11, 2019

RBI’s February Rate Cut—Surprising or not so.....

In an interesting move, unexpected by many, in the February 2019 policy review the RBI decided to change the stance of monetary policy from calibrated tightening to neutral and to reduce the policy repo rate by 25 basis points to 6.25 percent with a 4:2 majority vote. Consequently, the reverse repo rate under the LAF stands adjusted to 6.0%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.5%. Repo is the rate at which RBI lends to commercial banks, whereas reverse repo is the short-term borrowing rate at which the central bank borrows from other banks. The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate below which a bank is not permitted to lend, barring a few exceptional cases permitted by RBI.
This is the first rate cut announced by the MPC since August 2017 and marks a reversal in the rate cycle. Over the course of 2018, the MPC had raised rates twice by a total of 50 basis points to 6.5 percent.

In October, RBI had changed the policy stance to ‘calibrated tightening’ from neutral fearing that elevated core inflation poses upside risks to headline inflation. The shift in stance of monetary policy from calibrated tightening to neutral provides flexibility and the room to address the challenges to sustain growth of the Indian economy, as long as the inflation outlook remains benign, according to the latest policy announcement. The decisions of the MPC in this regard will be data driven and in consonance with the primary objective of monetary policy to maintain price stability.

The rate cut was not anticipated by a majority because it was against the RBI policy if inflation management and came at a time when there was no major downturn in growth, at least according to official data. Though headline inflation has softened considerably, the rate cut was a surprise given that the softening was mostly on account of the volatile food and fuel items, which showed a deflationary trend and expectations mostly in line with global cues as also seasonal factors. Any abatement in global trade tensions and already dovish US policy could well change inflationary expectations. Further, as per government statements the Indian economy is recording stellar performance which dilutes the need for a rate cut, particularly at a time when an expansionary budget had just been unveiled. The change of stance which implies from hawkish to neutral was expected, however, the dovish rate action caught analysts unawares, as it puts the central bank’s credibility at stake with doubts already hovering on the fiscal roadmap of the government.

The move, however, is not so surprising if one goes by a combination of factors mentioned by the RBI in its assessment and outlook, such as the slowdown in both external and domestic demand, weaker flows from institutional investors, borrowing costs remaining elevated, as well as a jobs report and higher frequency indicators showing signs of an economic slowdown. The statement on developmental and regulatory policies also reflects growth orientation. The highlight is the enhancement of the limit of collateral-free agriculture loan to Rs.1.60 lakh, to bring more farmers within the formal credit system. Neither is it surprising when one considers that in an election year, with the government unable to announce any measures for Industry in its February Budget presentation, the long standing demand for a rate cut should be met, given the change at the helm of RBI.

With the inflationary Interim budget and monetary policy being announced in tandem in the election year it will be interesting to see the stance and rate decisions in the subsequent monetary policies as inflation dynamics play out, particularly as core inflation, which is now a global benchmark has remained sticky, still hovering around near.6 percent.

Tuesday, February 5, 2019

Highlights of the Interim Budget 2019

This year’s Union Budget in February as per convention is an interim one awaiting results of elections to be held in May. A national Interim Budget refers to the budget of a government that is going through a transition period. The Interim Budget spans the transition time between the two governments in an election year so that the government can continue to function.  An Interim Budget usually is an account of income and expenditure and doesn't list out new schemes or doesn't unveil any policy measures. However, the ruling party at the Centre took this opportunity to reach out to a large electorate ahead of the Lok Sabha polls and presented a few new measures in form of tax rebates and benefits for the economically weaker sections.  
Following are the key highlights from the announcements made in the Interim Budget 2019-20:
- FY20 fiscal deficit target set at 3.4 percent
- Expenditure target for FY20 set at Rs 27.84 lakh crore
- Capital expenditure for FY20 set at Rs 3.36 lakh crore
- FY19 fiscal deficit pegged at 3.4 percent of GDP; current account deficit at 2.5 percent of GDP
- FY20 gilt repayment pegged at Rs 2.36 lakh crore
-Railway capital expenditure raised to Rs 64,586 crore in FY20 from Rs 53,060 crore in FY19
-Defence budget for FY20 raised to Rs 3 lakh crore

Taxation - Tax benefit of Rs 18,500 crore given to three crore middle-class tax payers
- Full tax rebate for income up to Rs 5 lakh per annum
-Income tax rebate for income up to Rs 6.5 lakh (Rs 5 lakh + Rs 1.5 lakh under 80C of the Income Tax Act)
- Standard deduction for salaried persons raised to Rs 50,000 from Rs 40,000
-Tax-free Gratuity limit increased from Rs 10 lakh to Rs 30 lakh
- TDS limit on bank and post-office savings hiked from Rs 10,000 to Rs 40,000
-TDS threshold on rental income raised from Rs 1.8 lakh to Rs 2.4 l lakh
- No tax on notional rent on second self-occupied house
- Benefit of rollover of capital tax gains under Section 54 to be increased from investment in one residential house to two, for capital gains up to 2 crore rupees
-Vision to create a tech enabled taxpayer friendly tax department
-Benefits under Sec 80(i)BA being extended for one more year for all housing projects approved till end of 2019-2020
-Businesses with less than Rs. 5 crore annual turnover, comprising over 90% of GST payers, will be allowed to file quarterly returns

Agricultural sector -Farmers with less than two hectares to be offered Rs 6,000 per year as direct transfer. Around 12 crore farmers to benefit from the scheme. This scheme will cost the government around Rs 75,000 crore (around 0.36% of the GDP (2019-20 Budget estimate).
-To provide Rs 750 crore in FY19 to support animal husbandry and fishing
-Farmers struck by natural calamities will now receive 2-5 percent interest subvention under insurance scheme
- Two percent interest subsidy to be given to farmers involved in animal husbandry activities via kisaan credit card scheme. An additional three percent subsidy will be paid on timely payment of loans
-Decision taken to increase MSP (minimum support price) by 1.5 times the production cost for all 22 crops

Micro, Medium and Small Enterprises (MSMEs) -2% interest rebate for MSMEs registered under GST for loans up to INR 1 crore
- Requirement of sourcing by government enterprises from SMEs increased up to 25%, of which, at least 3% to be sourced from women-led SMEs
-Government E-procurement Marketplace (GeM) platform extended to Central Public Sector Enterprises

Social security -Mega scheme has been announced for workers in the unorganised sector with a monthly income upto Rs 15,000. The scheme will provide them with an assured monthly pension of Rs 3,000. The scheme is contributory and the government will make a matching contribution
-Rs 60,000 crore allocated for MNREGA for FY20
-Employees' State Insurance eligibility cover limit has been raised to Rs 21,000 per month from Rs 15,000 per month
- Workers who suffer grievous injuries will now receive Rs 6 lakh from Rs 2.5 lakh through Employee Provident Fund Organisation (EPFO)

Income Tax rebates are provided for in place of increasing the non-Tax bracket as the government has made an explicit target to increase the number of tax filers in the country. In the Budget speech, it was pointed out that the number of returns filed has increased from 3.79 crore to 6.85 crore, a growth of 80% growth since 2014.
The Interim Budget announcements when implemented are likely to stimulate demand and boost economic growth, with a slew of benrfits for the middle class, farmers and workers in the unorganised sector, leading to more disposable income in their hands. The overall announcements are positive for consumption and investment, while being slightly negative for inflation, fiscal consolidation and bond markets. Analysts are also worried about how the revenue side estimates will actually pan out. The full budget, which is likely in July 2019, would have more details on spending and revenue mobilization.

Monday, January 28, 2019

Highlights of RBI’s Fifth Bi-monthly Monetary Policy Statement, 2018-19
Policy Measures

  •   The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50%.
  •    Consequently, the reverse repo rate under the LAF remains at 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75%.
       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. 

*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.

 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. 

Monday, September 24, 2018

Highlights of RBI’s Third Bi-monthly Monetary Policy Statement, 2018-19

Policy Measures
  • The Monetary Policy Committee (MPC) decided to increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.50%.
  • Consequently, the reverse repo rate under the LAF stands adjusted to 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.
  • 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. 

Global economic activity has continued to maintain steam; however, global growth has become uneven and risks to the outlook have increased with rising trade tensions. Among AEs, the US economy rebounded strongly in Q2, after modest growth in Q1, on the back of rising personal consumption expenditures and exports. In the Euro Area, weak growth in Q1 continued in Q2 due to subdued consumer demand, weighed down by political uncertainty and a strong currency. In Japan, recent data on retail sales, consumer confidence and business sentiment point to moderation in growth. Economic activity in major EMEs has slowed somewhat on volatile and elevated oil prices, mounting trade tensions and tightening of financial conditions. The Chinese economy lost some pace in Q2, pulled down by efforts to contain debt. The Russian economy picked up in Q1; recent data on employment, industrial production and exports indicate that the economy has gained further momentum. South Africa’s economy contracted in Q1; though consumer sentiment has improved, high unemployment and weak exports pose challenges. In Brazil, economic activity suffered a setback in Q1 on nation-wide strikes; more recent data suggest that growth remained muted as industrial production contracted in May and the manufacturing PMI declined.
Global trade lost some traction due to intensification of trade wars and uncertainty stemming from Brexit negotiations. Crude oil prices, which remained volatile and elevated in May-June on a delicate demand-supply balance, eased modestly in the second half of July on higher supply from OPEC and non-OPEC producers. Base metal prices have fallen on the general risk-off sentiment triggered by fears of an intensification of trade wars. Gold prices have softened on a stronger dollar. Inflation remained firm in the US, reflecting higher oil prices and stronger aggregate demand. Inflation has edged up also in some other major advanced and emerging economies, driven, in part, by rising energy prices and pass-through effects from currency depreciations.

Global financial markets have continued to be driven mainly by monetary policy stances in major AEs and geopolitical tensions. Equity markets in AEs have declined on trade tensions and uncertainty relating to Brexit negotiations. Investors’ appetite for EME assets has waned on increases in interest rates by the US Fed. The 10-year sovereign yield in the US has moderated somewhat from its peak on May 17 on safe-haven demand, spurred by escalating trade conflicts. Yields have softened in other key AEs as well. In most EMEs, however, movements in yields have varied reflecting domestic macroeconomic fundamentals and tightening global liquidity. Capital flows to EMEs declined in anticipation of monetary policy tightening in AEs. In currency markets, the US dollar appreciated, supported by strong economic data. The euro strengthened in June on receding political uncertainty and taper talk by the central bank. However, the currency has traded soft thereafter on mixed economic data and the rising US dollar. EME currencies, in general, have depreciated against the US dollar over the last month.

In India IIP strengthened in April-May 2018 on a y-o-y basis. This was driven mainly by a significant turnaround in the production of capital goods and consumer durables. Growth in the infrastructure/construction sector accelerated sharply, reflecting the government’s thrust on national highways and rural housing, while the growth of consumer non-durables decelerated significantly. The output of eight core industries accelerated in June due to higher production in petroleum refinery products, steel, coal and cement. Capacity utilisation in the manufacturing sector remains robust. The assessment based on the Reserve Bank’s business expectations index (BEI) for Q1:2018-19 remained optimistic notwithstanding some softening in production, order books and exports. The July manufacturing PMI remained in expansion zone, although it eased from its level a month ago with slower growth in output, new orders and employment.

 Retail inflation, measured by year-on-year change in the CPI rose from 4.9 per cent in May to 5 per cent in June, driven by an uptick in inflation in fuel and in items other than food and fuel even as food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation. Fuel and light group inflation rose sharply, pulled up by LPG and kerosene, while electricity inflation remained low. The pass-through of global crude oil prices impacted inflation in domestic petroleum products as well as transport services. Inflation also picked up modestly in respect of education and health. The June round of the Reserve Bank’s survey of households reported a further uptick of 20 basis points in inflation expectations for both three-month and one-year ahead horizons as compared with the last round. Manufacturing firms polled in the Reserve Bank’s industrial outlook survey reported higher input costs and selling prices in Q1:2018-19. The manufacturing PMI showed that input prices eased slightly in July, although they remained high. Input costs for companies polled in Services PMI in June also stayed elevated. Farm and non-farm input costs rose significantly. Notwithstanding some pick-up in February and March 2018, rural wage growth remained moderate, while wage growth in the organised sector remained firm.

The liquidity in the system remained generally in surplus mode during June-July 2018. In June, the Reserve Bank absorbed surplus liquidity of around Rs.140 billion on a daily net average basis under the LAF even as the system migrated from net surplus to a net deficit mode in the second half of the month due to advance tax outflows. Interest rates in the overnight call money market firmed up in June reflecting the increase in the repo rate on June 6, 2018. The weighted average call rate (WACR) traded, on an average, 12 basis points below the repo rate – the same as in May. Systemic liquidity moved back into surplus mode in early July with increased government spending but turned into deficit from July 10 onwards; on a daily net average basis, the Reserve Bank injected liquidity under the LAF of Rs.107 billion in July. The WACR in July, on an average, traded 9 basis points below the policy rate. Based on an assessment of prevailing liquidity conditions and of durable liquidity needs going forward, the Reserve Bank conducted two open OMO purchase auctions of Rs.100 billion each on June 21 and July 19, 2018.

Merchandise exports growth picked up in May and June 2018 on a y-o-y basis, aided by engineering goods, petroleum products, drugs and pharmaceuticals, and chemicals. During the same period, merchandise import growth also accelerated largely due to an increase in crude oil prices. Among non-oil imports, gold imports declined due to lower volume, while imports of machinery, coal, electronic goods, chemicals, and iron and steel increased sharply. Double-digit import growth in May and June pushed up the trade deficit. While net FDI inflows improved significantly in the first two months of 2018-19, with the tightening of liquidity conditions in AEs, growing geopolitical concerns and with the escalation of protectionist sentiment, net FPI outflows from the domestic capital market have continued, albeit at an increasingly slower rate. India’s foreign exchange reserves were at US$404.2 billion on July 27, 2018.

 GDP growth outlook for 2018-19 is retained at 7.4 per cent as in the April policy. GDP growth is projected in the range of 7.5-7.6 per cent in H1 and 7.3-7.4 per cent in H2, with risks evenly balanced. Various indicators suggest that economic activity has continued to be strong. The progress of the monsoon so far and a sharper than the usual increase in MSPs of kharif crops are expected to boost rural demand by raising farmers’ income. Robust corporate earnings, especially of fast moving consumer goods (FMCG) companies, also reflect buoyant rural demand. Investment activity remains firm even as there has been some tightening of financing conditions in the recent period. Increased FDI flows in recent months and continued buoyant domestic capital market conditions bode well for investment activity. The Reserve Bank’s IOS indicates that activity in the manufacturing sector is expected to remain robust in Q2, though there may be some moderation in pace. Rising trade tensions may, however, have an adverse impact on India’s exports.

Headline inflation outlook is driven primarily by several factors. First, the central government has decided to fix the MSPs of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19. This increase in MSPs, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and second round effects on headline inflation. A part of the increase in MSPs based on historical trends was already included in the June baseline projections. However, there is a considerable uncertainty and the exact impact would depend on the nature and scale of the government’s procurement operations. Second, the overall performance of the monsoon so far augurs well for food inflation in the medium-term. Third, crude oil prices have moderated slightly, but remain at elevated levels. Fourth, the central government has reduced GST rates on several goods and services. This will have some direct moderating impact on inflation, provided there is a pass-through of reduced GST rates to retail consumers. Fifth, inflation in items excluding food and fuel has been broad-based and has risen significantly in recent months, reflecting greater pass-through of rising input costs and improving demand conditions. Finally, financial markets continue to be volatile. Based on an assessment of the above-mentioned factors, inflation is projected at 4.6 per cent in Q2 and 4.8 per cent in H2 of 2018-19, with risks evenly balanced. Excluding the HRA impact, CPI inflation is projected at 4.4 per cent in Q2 and 4.7-4.8 per cent in H2.

Developmental and Regulatory Policies
  • Extension of MSF to Scheduled Primary (Urban) Cooperative Banks, and extension of LAF and MSF to Scheduled State Cooperative Banks, complying with the eligibility criteria prescribed for LAF / MSF, as part of the Reserve Bank’s continuous efforts in improving the transmission of monetary policy to money market rates.
  • Investment in Non-SLR Securities by Primary (Urban) Cooperative Banks. In order to bring further efficiency in price discovery mechanism and as a step towards harmonization of regulations they will be permitted to undertake eligible transactions for acquisition / sale of non-SLR investment in secondary market with mutual funds, pension / provident funds, and insurance companies. This is in addition to undertaking eligible transactions with Scheduled Commercial Banks and Primary Dealers.    
  • Co-origination of loans by Banks and Non-Banking Financial Companies (NBFCs) for lending to the priority sector to provide the much-needed competitive edge for credit to the priority sector. All SCBs (excluding Regional Rural Banks and Small Finance Banks) may co-originate loans with NBFCs - NBFC-ND-SIs, for the creation of eligible priority sector assets. The co-origination arrangement should entail joint contribution of credit by both lenders at the facility level. It should also involve sharing of risks and rewards between the banks and the NBFCs for ensuring appropriate alignment of respective business objectives, as per their mutual agreement.

Financial Markets
  • Review of Foreign Exchange Derivative facilities for Residents (Regulation FEMA-25):  It is now proposed to undertake a comprehensive review of FEMA 25, in consultation with the Government of India, to, inter alia, reduce the administrative requirements for undertaking derivative transactions, allow dynamic hedging, and allow Indian multinationals to hedge the currency risks of their global subsidiaries from India.
  • Comprehensive Review of Market Timings: It is necessary that timings across products and funding markets complement each other and avoid unanticipated frictions. It is, therefore, proposed, to set up an internal group to comprehensively review timings of various markets and the necessary payment infrastructure for supporting the recommended revisions to market timings. 
  • Review of SGL/ CSGL Guidelines: In order to facilitate greater participation in the G-Secs markets and to provide market participants further operational ease in opening and operating of Subsidiary General Ledger (SGL) and Constituent Subsidiary General Ledger (CSGL) Accounts, it has been decided to review comprehensively the SGL/CSGL Guidelines. 

Wednesday, March 21, 2018

Highlights of RBI’s Sixth Bi-monthly Monetary Policy Statement, 2017-18:

Policy Measures
  • The Monetary Policy Committee (MPC) decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.00%.
  • Consequently, the reverse repo rate under the LAF remains unchanged at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate are at 6.25%.
  • 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. 
Global economic activity has gained further pace with growth impulses becoming more synchronised across regions. Among AEs, the Euro area expanded at a robust pace, supported by consumption and investment. The US economy lost some momentum with growth slowing down in Q4 of 2017 even as manufacturing activity touched a multi-month high in December. The Japanese economy continued to grow as manufacturing activity gathered pace in January on strong external demand. Economic activity accelerated in EMEs) in the final quarter of 2017. The Chinese economy grew above the official target, driven by strong domestic consumption and robust exports. However, some downside risks to growth remain, especially from easing fixed asset investment and surging debt levels. In Russia, strong private consumption, rising oil prices and high exports are supporting economic activity, although weak investment and economic sanctions are weighing on its growth prospects. In Brazil, data on household spending and unemployment were positive in Q4. However, recovery remains vulnerable to political uncertainty, which has dampened consumer confidence. South Africa continues to face challenges on both domestic and external fronts, including high unemployment and declining factory activity.

Global trade continued to expand, underpinned by strong investment and robust manufacturing activity. Crude oil prices touched a three-year high as production cuts by the OPEC coupled with falling inventories weighed on the global demand-supply balance. Bullion prices touched a multi-month high on a weak US dollar. Inflation remained contained in most AEs and was divergent in key EMEs due to country-specific factors.

Global financial markets have become volatile in recent days due to uncertainty over the pace of normalisation of the US Fed monetary policy. The volatility index (VIX) has climbed to its highest level since Brexit. Equity markets have witnessed a sharp correction, both in AEs and EMEs. Bond yields in the US have hardened sharply, adding to the upward pressures seen during January, with concomitant rise in bond yields in other AEs and EMEs. Forex markets have become volatile as well. Until this episode of recent volatility, global financial markets were buoyed by investor appetite for risk, corporate tax cuts by the US, and stable economic conditions. Equity markets had gained significantly in January, driven by robust Chinese growth, uptick in commodity prices, and positive corporate sentiment in general. In currency markets, the US dollar had touched a multi-month low on February 1 on fiscal risks and improving growth prospects in other AEs.

In India as per the first advance estimates released by the CSO is estimated to decelerate to 6.1 per cent in 2017-18 from 7.1 per cent in 2016-17 due mainly to slowdown in agriculture and allied activities, mining and quarrying, manufacturing, and public administration and defence services. Manufacturing output boosted the growth of IIP in November. After a period of prolonged weakness, cement production registered robust growth in November-December, which along with continuing healthy growth in steel production led to acceleration of infrastructure goods production in November. The manufacturing purchasing managers’ index (PMI) expanded for the sixth consecutive month in January led by new orders. Assessment of overall business sentiment in the Indian manufacturing sector improved in Q3 as reflected in the Reserve Bank’s Industrial Outlook Survey (IOS). However, core sector growth decelerated in December due to contraction/deceleration in production of coal, crude oil, steel and electricity. Acreage in the case of wheat, oilseeds and coarse cereals was lower than last year and there was a higher shortfall in area sown for rabi crops as of end-January.

 Retail inflation, measured by year-on-year change in the CPI, increased for the sixth consecutive month in December on account of a strong unfavourable base effect. After rising abruptly in November, food prices reversed partly in December, reflecting mainly the seasonal moderation, albeitmuted, in prices of vegetables along with continuing decline in prices of pulses. Cereals inflation moderated with prices remaining steady in December. However, inflation in some components of food – eggs; meat and fish; oils and fats; and milk – increased. Fuel and light group inflation, which showed a sharp increase in November, softened somewhat in December, driven by moderation in electricity, LPG and kerosene inflation.
CPI inflation excluding food and fuel, increased further in November and December, largely on account of increase in housing inflation following the implementation of higher HRA for government employees under the 7th CPC award. Inflation also picked up in health and personal care and effects. Reflecting incomplete pass-through to domestic petroleum product prices, inflation in transport and communication remained muted in December. Inflation also slowed down in clothing and footwear, household goods and services, recreation, and education. Organised sector wage growth remained firm, while the rural wage growth decelerated.

The liquidity in the system continues to be in surplus mode, but it is moving steadily towards neutrality. The weighted average call rate (WACR) traded 12 bps below the repo rate during December-January as against 15 bps below the repo rate in November. On some days in December and January, the system turned into deficit due to slow down in government spending and large tax collections, which necessitated injection of liquidity by the Reserve Bank. For December as a whole, however, the Reserve Bank absorbed Rs. 316 billion (on a net daily average basis). For January, on the whole, the Reserve Bank absorbed Rs. 353 billion.

Merchandise exports bounced back in November and December. While petroleum products, engineering goods and chemicals accounted for three-fourths of this growth, exports of readymade garments contracted. During the same period, merchandise import growth accelerated sequentially with over one-third of the growth emanating from petroleum (crude and products) due largely to high international prices. Gold imports increased – both in value and volume terms – in December, after declining in the preceding three months. Pearls and precious stones, electronic goods and coal were major contributors to non-oil non-gold import growth. With import growth exceeding export growth, the trade deficit for December was US$ 14.9 billion. Even though the current account deficit narrowed sharply in Q2 of 2017-18 on a sequential basis, it was higher than its level a year ago, mainly due to widening of the trade deficit. While net FDI inflows moderated in April-October 2017 from their level a year ago, net FPI inflows were buoyant in 2017-18 (up to February 1). India’s foreign exchange reserves were at US$ 421.9 billion on February 2, 2018.
 GVA growth for 2017-18 is projected at 6.6 per cent. Beyond the current year, the growth outlook will be influenced by several factors. First, GST implementation is stabilising, which augurs well for economic activity. Second, there are early signs of revival in investment activity as reflected in improving credit offtake, large resource mobilisation from the primary capital market, and improving capital goods production and imports. Third, the process of recapitalisation of public sector banks has got underway. Large distressed borrowers are being referenced for resolution under the Insolvency and Bankruptcy Code (IBC). This should improve credit flows further and create demand for fresh investment. Fourth, although export growth is expected to improve further on account of improving global demand, elevated commodity prices, especially of oil, may act as a drag on aggregate demand. 

Headline inflation averaged 4.6 per cent in Q3, driven primarily by an unusual pick-up in food prices in November. Though prices eased in December, the winter seasonal food price moderation was less than usual. Domestic pump prices of petrol and diesel rose sharply in January, reflecting lagged pass-through of the past increases in international crude oil prices. Considering these factors, inflation is now estimated at 5.1 per cent in Q4, including the HRA impact.
Developmental and Regulatory Policies
  • Relief for MSME Borrowers: (for which the aggregate exposure of banks and NBFCs does not exceed ₹ 250 million as on January 31, 2018), MSMEs who have registered under GST, be allowed by banks and NBFCs to pay the amounts overdue as on September 1, 2017 and payments due between September 1, 2017 and January 31, 2018, within 180 days from their original due date, as a measure to support their transition to a formalised business environment.
  • Remove the currently applicable loan limits of Rs. 50 million and Rs. 100 million per borrower to Micro, Small and Medium Enterprises, (Services) respectively, for classification under priority sector.
  • It has been decided that the sub-target of 8 percent of Adjusted Net Bank Credit (ANBC) or Credit Equivalent Amount of Off-Balance Sheet Exposure (CEOBE), whichever is higher, will be made applicable for lending to the small and marginal farmers for foreign banks with 20 branches and above from FY 2018-19. Further, the sub-target for bank lending to the Micro Enterprises in the country of 7.50 percent of ANBC or CEOBE, whichever is higher, will also be made applicable for foreign banks with 20 branches and above from FY 2018-19.
  • It has been decided to harmonize the methodology of determining benchmark rates by linking the Base Rate to the MCLR with effect from April 1, 2018. 
  • With a view to harmonizing regulations across different types of collateral and also to encourage wider participation, especially for corporate debt repos, the repo directions are proposed to be streamlined and simplified. 
  • It is now proposed to allow non-residents hedging their INR currency risk arising out of their current and capital account transactions to dynamically hedge their currency and interest rate exposures onshore using any of the permitted instruments.
  • It is now proposed to merge position limits across all foreign currency-INR pairs and provide a single limit of USD 100 million per user (both resident and non-resident) across all exchange traded currency derivatives, in all exchanges combined. 
  • It is proposed that (i) FBIL would assume the responsibility for standardising the valuation of Government securities (issued by both the Centre and States) currently being done by FIMMDA; and, (ii) FBIL would also assume the responsibility for computation and dissemination of the daily “Reference Rate” for Spot USD/INR and other major currencies against the Rupee, which is currently being done by the Reserve Bank.
  • With a view to providing customers of NBFCs with a cost-free and expeditious grievance redress mechanism, it has been decided to introduce an Ombudsman Scheme for NBFCs. The scheme will cover all deposit taking NBFCs and those with customer interface having asset-size of Rupees One Billion and above. 
  • Standardize the note printing processes, procurement of raw materials, quality assurance processes, security, etc.
  • With a view to promote a less cash economy it has been decided to discontinue the incentives for installation of Cash Recycler Machines (CRMs) and Automated Teller Machines (ATMs).