Revival in high-frequency indicators shows modest growth momentum recovery

Despite expectations of a moderation in inflation from the elevated level of 7.35% in Dec 2019, the RBI's MPC expects a hardening of prices of other food items, notably those of pulses and proteins

This was a “no-event policy” of the Reserve Bank of India (RBI) in terms of monetary measures, as the “status quo” and "continuation of accommodative stance" were in line with expectations.

The Monetary Policy Committee (MPC) of the RBI has kept the repo rate, as well as the reverse repo rate, under the liquidity adjustment facility (LAF), unchanged at 5.15 per cent and 4.9 per cent, respectively, and has also decided to continue with the accommodative stance, considering the need to revive growth and because the inflation rate conforms to the target.

The MPC has projected the GDP growth at 6.0 per cent for 2020-21, in the range of 5.5-6.0 per cent in the first half of the year and 6.2 per cent in Q3 FY21. The projections are in line with our expectations of 5.5-6 per cent for the next financial year. 

A revival in high-frequency indicators hints at a modest improvement in growth momentum. The RBI’s business expectations index suggests a sharp rise in Q4, which is corroborated by the manufacturing purchasing managers’ index (PMI) for January 2020 peaking to an 8-year high of 55.3, on the back of an increased output and new orders. Several high-frequency indicators of services have also turned upwards lately.

Improved private consumption, considering better agricultural output and better terms of trade towards agriculture, easing of global trade market conditions due to improved performance of the global economy, further easing of lending rates, and a reduction in the personal income-tax rates in the recently presented Budget are also likely to support the growth outlook.

One of the noteworthy observations in the policy is the vigilant outlook on inflation by the MPC. As mentioned in our pre-policy expectations, the consumer price index (CPI)-based inflation crossed MPC’s upper-band target in December 2019, for the first time since the MPC was formed, primarily on the back of an unusual spike in onion prices.

Despite expectations of a moderation in inflation from the elevated level of 7.35 per cent in December 2019, the RBI's MPC expects a hardening of prices of other food items, notably those of pulses and proteins. That may keep headline inflation elevated in the short run, at least through the first half of 2020-21. CPI-based inflation projections have been revised upwards to 6.5 per cent for Q4 of 2019-20, and 5.4-5.0 per cent for the first half of 2020-21. Several of the underlying factors indicate continued inflationary pressures. We expect the MPC to adopt a cautious approach in its next policy as well, till the time inflation moves within its comfort zone. In the statement, the MPC has also recognised that there is policy space available for future action. If the inflation cools down and growth concerns continue, we can expect the much-needed monetary easing in the next policy.

RBI has also released a statement on Developmental and Regulatory Policies announcing some important initiatives.

• In order to ensure adequate liquidity to enable banks to augment credit flows to productive sectors, from the fortnight beginning on February 15, 2020, the RBI would conduct term repos of one-year and three-year tenors of appropriate sizes amounting to a total of Rs one lakh crore at the policy repo rate. This move has the potential to bring down cost of funds of the banks that utilise the LAF window on a regular basis providing an additional source of funding.

• Incentivising banks by giving leeway in CRR on incremental lending to certain productive sectors like auto, housing and Micro, Small and Medium Enterprises (MSMEs) which will have multiplier effect on various sectors and economy as a whole. This will improve sentiments for lending, reduce banks’ funding cost and thus ensure better transmission of rates and also increase the flow of funds to these sectors.

• With a view to further strengthen monetary transmission, pricing of loans by SCBs for medium enterprises will be linked to an external benchmark effective April 1, 2020. A one-time restructuring of loans to MSMEs that were in default as on January 1, 2019, is permitted  without an asset classification downgrade considering the importance of MSMEs. This is in addition to the measure announced in Union Budget 2020-21, and will provide much needed relief for the cash-starved MSMEs. 

(The author is chief economic advisor at Brickwork Ratings. Views are personal)