RBI second bi-monthly Monetary Policy statement for 2019-20 – Read full text

New Delhi: The six-member Monetary Policy Committee (MPC) headed by RBI Governor Shaktikanta Das on Thursday announced reduction of repo rates by 25 basis points to 5.75 percent in its second bi-monthly monetary policy of 2019-20 on Thursday.

Here is the full text of RBI's second bi-monthly Monetary Policy statement for 2019-20

On  the  basis  of  an  assessment  of  the  current  and  evolving  macroeconomic  situation,  the  Monetary Policy Committee (MPC) at its meeting today decided to:

reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 5.75 per cent from 6.0 per cent with immediate effect.

Consequently, the reverse repo rate under the LAF stands adjusted to 5.50 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.0 per cent.

The MPC also decided to change the stance of monetary policy from neutral to accommodative.

These  decisions  are  in  consonance  with  the  objective  of  achieving  the  medium-term  target  for  consumer  price  index  (CPI)  inflation  of  4  per  cent  within  a  band  of  +/-   2  per  cent,  while  supporting  growth.

The main considerations underlying the decision are set out in the statement below.

Assessment

Global Economy

2.Global  economic  activity  has  been  losing  pace  after  a  somewhat  improved  performance  in  Q1:2019,   reflecting   further   slowdown   in   trade   and   manufacturing   activity.   Among   advanced   economies  (AEs),  economic  activity  in  the  US  strengthened  in  Q1,  supported  by  higher  government  spending, increase in private investment and a lower trade deficit. However, factory activity and retail sales  moderated  in  April.  Economic  activity  in  the  Euro  area  has  remained  weak  due  to  muted  industrial activity and weak business confidence. Leading indicators point to a further slowdown in the Euro  area  in  Q2.  In  the  UK,  GDP  growth  for  Q1  picked  up  on  high  retail  sales  and  government  expenditure. However, the outlook is clouded by uncertainty relating to Brexit. The Japanese economy accelerated in Q1 on net exports gains and increased public investment. In April, industrial production improved, while retail sales fell.

3.Economic activity has slowed in many emerging market economies (EMEs). In Q1:2019, the Chinese  economy  grew  at  the  same  pace  as  in  the  previous  quarter,  though  slightly  above  consensus  expectations. However, incoming data on industrial production and retail sales suggest that the growth momentum  may  weaken  in  Q2.  The  Russian  economy,  which  had  shown  some  signs  of  recovery  in  Q4:2018,  weakened  in  Q1  on  muted  domestic  activity  and  trade.  Economic  activity  in  South  Africa  contracted in Q1 pulled down mainly by a sharp decline in manufacturing activity. Brazil’s economy contracted in Q1 for the first time since 2016 and there are fears that it could return to recession.

4.Crude oil prices remained volatile, reflecting evolving demand-supply conditions underpinned by  the  production  stance  of  the  OPEC  plus,  rising  shale  output,  weakening  global  demand  and  geo-political  concerns.  The  strengthening  of  the  US  dollar  had  weakened  gold  prices;  however,  prices  picked up since the last week of May on escalating trade tensions, reviving its demand as a safe haven asset. Inflation remains below target in several economies, though it has shown an uptick since March.

5.Financial markets have been driven by uncertainties surrounding US-China trade negotiations and Brexit.  In the US, the equity market has experienced some selling pressures since early May on escalation of trade tensions with China and recently, with Mexico. Equity markets in most EMEs have lost  steam  due  to  the  waning  risk  appetite  on  rising  geo-political  uncertainties  and  weakening  global  trade prospects. Bond yields in the US picked up in April on better GDP data for Q1, but declined in May on subdued economic data and expectations of a dovish monetary policy stance. Bond yields in Germany slipped into negative territory on weak economic data; in Japan, they remained negative on indications  of  sustained  accommodation.  In  many  EMEs,  bond  yields  have  been  falling  with  central  banks  adopting  accommodative  monetary  policy  to  boost  economic  growth.  In  currency  markets,  the  US dollar strengthened on better than expected domestic economic data for Q1. Most EME currencies have depreciated against the US dollar.

Domestic Economy

6.Turning  to  the  domestic  economy,  on  May  31,  2019  the  National  Statistical  Office  (NSO)  released  quarterly  estimates  of  gross  domestic  product  (GDP)  for  Q4:2018-19  and  provisional  estimates of national income for 2018-19. GDP growth for 2018-19 has been estimated at 6.8 per cent year-on-year (y-o-y), down by 20 basis points from the second advance estimates released on February 28,  pulled  down  by  a  downward revision  in  private  final  consumption  expenditure  (PFCE)  and  moderation in exports. Quarterly data show that domestic economic activity decelerated sharply to 5.8 per  cent  in  Q4:2018-19  from  6.6  per  cent  in  Q3  and  8.1  per  cent  in  Q4:2017-18.  Gross  fixed  capital formation  (GFCF)  growth  declined  sharply  to  3.6  per  cent,  after  remaining  in  double  digits  in  the  previous  five  quarters.  Private  consumption  growth  also  moderated.  The  drag  on  aggregate  demand  from net exports increased in Q4 due to a sharper deceleration in exports relative to imports. However, the  overall  slowdown  in  growth  was  cushioned  by  a  large  increase  in  government  final  consumption  expenditure (GFCE).

7.On the supply side, agriculture and allied activities contracted, albeitmarginally, in Q4:2018-19  due  to  a  decline  in  rabi production. According  to  the  third  advance  estimates,  foodgrains  production at 283.4 million tonnes for 2018-19 was lower by 0.6 per cent compared with the previous year mainly due to lower production of rabi rice, pulses and coarse cereals. However, there has been a catch-up  in  foodgrains  production  relative  to  earlier  estimates.  Foodgrains  stocks  at  72.6  million  tonnes  as  on  May  16,  2019  were  3.4  times  the  prescribed  buffer  norms.  Growth  in  manufacturing  activity  weakened  sharply  to  3.1  per  cent  from  6.4  per  cent  in  the  previous  quarter.  Service  sector  growth, however, accelerated, supported by financial, real estate and professional services, and public administration, defence and other services. In contrast, construction activity slowed down markedly.

8.Moving beyond Q4, the India Meteorological Department (IMD) has predicted that south-west monsoon rainfall (June to September) is likely to be normal at 96 per cent of the long period average (LPA).  The  current  weak  El  Niño conditions  over  the  Pacific  are  likely  to  continue  during  the  monsoon.  However,  currently  prevailing  neutral  Indian  Ocean  Dipole  (IOD)  conditions  may  turn  positive in the middle of the monsoon season and persist thereafter, which augur well for the rainfall outlook.

9.Growth  in  eight  core  industries  decelerated  sharply  in  April,  pulled  down  largely  by  coal,  crude oil, fertilisers and cement.  Credit flows from banks to large industries strengthened, though they remained muted for micro, small and medium industries. Based on early results of the Reserve Bank’s order  books,  inventory  and  capacity  utilisation  survey  (OBICUS),  capacity  utilisation  (CU)  in  the  manufacturing sector improved to 77 per cent in Q4 from 75.9 per cent in Q3; seasonally adjusted CU, however, slipped marginally to 75.2 per cent in Q4 from 75.8 per cent in Q3. The business assessment index (BAI) of the industrial outlook survey (IOS) in Q1:2019-20 remained unchanged at its level in the  previous  quarter.  Imports  of  capital  goods  –  a  key  indicator  of  investment  activity  –  remained
anaemic in April. However, the manufacturing purchasing managers’ index (PMI) edged up to 52.7 in May with strengthening of output, new orders and employment.

10.High  frequency  indicators  suggest  moderation  in  activity  in  the  service  sector.  Sales  of  commercial vehicles, tractors, passenger cars, and three and two wheelers contracted in April. Railway freight  traffic  growth  decelerated.  Domestic  air  passenger  traffic  growth  contracted  in  March,  but  turned aroundmodestly in April. Two key indicators of construction activity, viz., cement production and steel consumption, slowed down in April.  The PMI services index moderated to 50.2 in May on subdued growth of new businesses.

11.Retail inflation, measured by y-o -y change in CPI, remained unchanged in April, at its March level  of  2.9  per  cent,  with  higher  inflation  in  food  and  fuel  groups  being  offset  by  lower  inflation  in  items excluding food and fuel.

12.The April food inflation print showed an increase to 1.4 per cent from 0.7 per cent in March. Within the food group, vegetables moved out of nine months of deflation. However, three sub-groups, viz., fruits, pulses and sugar, remained in deflation in April, though the extent of deflation moderated. Among  other  food  sub-groups,  inflation  in  prices  of  milk,  oils  and  fats,  spices,  non-alcoholic beverages and prepared meals moderated, while inflation in meat, fish and eggs prices ticked up.

13.Inflation in the fuel and light group rose to 2.6 per cent in April from the February trough of 1.2 per cent, pulled up by prices of liquified petroleum gas due to an increase in international prices. Inflation  in  subsidised  kerosene  also  rose,  reflecting  the  impact  of  the  calibrated  increase  in  its  administered price. Electricity prices moved out of three months of deflation in April. Prices of rural fuel consumption items – firewood, chips and dung cake – moved into deflation.

14.CPI inflation excluding food and fuel fell sharply to 4.5 per cent in April from 5.1 per cent in March –  the  largest  monthly  decline  since  April  2017.  The  moderation  in  inflation  was  broad-based, with household goods and services, and personal care and effects sub-groups registering the largest fall in April; housing inflation was the lowest since June 2017, reflecting softening in house rents in urban areas. Inflation in clothing and footwear also touched its historical low in the new all-India CPI series. Inflation in education, health and transportation and communication moderated as well.

15.Inflation  expectations  of  households  in  the  May  2019  round  of  Reserve  Bank’s  survey  declined by 20 basis points for the three-month ahead horizon compared with the previous round, but remained  unchanged  for  the  one-year  ahead  horizon.  However,  manufacturing  firms  participating  in  the  Reserve  Bank’s  industrial  outlook  survey  expect  input  cost  pressures  to  intensify  on  account  of  higher  raw  material  costs  and  salaries  in  Q2.  Input  price  pressures  eased  in  both  agricultural  and  industrial  raw  materials.  Nominal  growth  in  rural  wages  and  in  organised  sector  staff  costs  remained  muted.   

16.Liquidity in the system turned into an average daily surplus of  ₹66,000 crore (₹660 billion) in early  June  after  remaining  in  deficit  during  April  and  most  of  May  due  to  restrained  government  spending.  The  Reserve  Bank  injected  liquidity  of ₹70,000  crore  (₹700  billion)  in  April  and  ₹33,400 crore  (₹334  billion)  in  May  on  a  daily  net  average  basis  under  the  LAF.  It  conducted  two  OMO purchase  auctions  in  May  amounting  to  ₹25,000  crore  (₹250  billion)  and  a  US  dollar  buy/sell  swap auction of US$ 5 billion (₹34,874 crore) for a tenor of 3 years in April to inject durable liquidity into the system. The weighted average call money rate (WACR) – the operating target of monetary policy –  remained  broadly  aligned  with  the  policy  repo  rate:  it  traded  above  the  policy  repo  rate  (on  an  average)  by  6  bps  in  April,  but  below  the  policy  repo  rate  by  6  bps  in  May.    The  Reserve  Bank  has  announced that it would conduct an OMO purchase auction of ₹15,000 crore (₹150 billion) on June 13, 2019.

17.Transmission  of  the  cumulative  reduction  of  50  bps  in  the  policy  repo  rate  in  February  and  April 2019 was 21 bps to the weighted average lending rate (WALR) on fresh rupee loans. However, the  WALR  on  outstanding  rupee  loans  increased  by  4 bps  as  the  past  loans  continue  to  be  priced  at  high rates. Interest rates on longer tenor money market instruments remained broadly aligned with the overnight WACR, reflecting near full transmission of the reduction in policy rate.

18.Exports were unable to sustain the growth of 11.8 per cent observed in March 2019; they grew by  0.6  per  cent  in  April  2019  dragged  down  by engineering  goods,  gems  and  jewellery,  and  leather  products. Imports grew at a somewhat accelerated pace in April 2019 relative to the preceding month, driven  by  imports  of  petroleum  (crude  and  products),  gold  and  machinery.  This  led  to  a  widening  of  the  trade  deficit,  both  sequentially  and  on  a  y-o -y  basis.  Provisional  data  suggest  that  net  services  exports  in  Q4:2018-19  were  broadly  comparable  to  their  level  a  year  ago  which  bode  well  for  the  current  account  balance.  On  the  financing  side,  net  foreign  direct  investment  flows  were  stronger  in  Q4:2018-19 than a year ago. After a sharp recovery in March 2019, net foreign portfolio inflows were relatively modest at US$ 2.3 billion in 2019-20 in April-May. While the equity segment received net inflows during this period, the debt segment witnessed net outflows. India’s foreign exchange reserves were at US$ 421.9 billion on May 31, 2019.

Outlook

19.In the bi-monthly monetary policy resolution of April 2019, CPI inflation was projected at 2.4 per  cent  for  Q4:2018-19,  2.9-3.0  per  cent  for  H1:2019-20  and  3.5-3.8  per  cent  for  H2:2019-20,  with  risks broadly balanced. The headline inflation outcome in Q4 at 2.5 per cent was largely in alignment with the April policy projections.  

20.The  baseline  inflation  trajectory  for  2019-20  is  shaped  by  several  factors.  First,  the  summer  pick-up  in  vegetable  prices  has  been  sharper  than  expected,  though  this  may  be  accompanied  by  a  correspondingly  larger  reversal  during  autumn  and  winter.  More  recent  information  also  suggests  a  broad-based  pick-up  in  prices  in  several  food  items.    This  has  imparted  an  upward  bias  to  the  near-term  trajectory  of  food  inflation.  Second,  a  significant  weakening  of  domestic  and  external  demand  conditions appear to have led to a sharp broad-based decline of 60 bps in inflation excluding food and fuel  in  April;  this  has  imparted  a  downward  bias  to  the  inflation  trajectory  for  the  rest  of  the  year.  Third, crude prices have continued to be volatile. However, its impact on CPI inflation has been muted so  far  due  to  incomplete  pass-through.  Fourth,  near-term  inflation expectations  of  households  have  continued  to  moderate.  Taking into  consideration  these  factors,  the  impact  of  recent  policy  rate  cuts  and expectations of a normal monsoon in 2019, the path of CPI inflation is revised to 3.0-3.1 per cent for H1:2019-20 and to 3.4-3.7 per cent for H2:2019-20, with risks broadly balanced (Chart 1).  

21.Risks  around  the  baseline  inflation  trajectory  emanate  from  uncertainties  relating  to  the  monsoon,  unseasonal  spikes  in  vegetable  prices,  international  fuel  prices  and  their  pass-through  to  domestic prices, geo-political tensions, financial market volatility and the fiscal scenario.

22.In  the  April  policy,  GDP  growth  for  2019-20  was  projected  at  7.2  per  cent  –  in  the  range  of  6.8-7.1 per cent for H1 and 7.3-7.4 per cent for H2 – with risks evenly balanced. Data for Q4:2018-19 indicate that domestic investment activity has weakened and overall demand has been weighed down partly  by  slowing  exports.  Weak  global  demand  due  to  escalation  in  trade  wars  may  further  impact  India’s  exports  and  investment  activity.  Further,  private  consumption,  especially in  rural  areas,  has  weakened in recent months. However, on the positive side, political stability, high capacity utilisation, the uptick in business expectations in Q2, buoyant stock market conditions and higher financial flows to  the  commercial  sector  augur  well  for  investment  activity.  Taking  into  consideration  the  above  factors and the impact of recent policy rate cuts, GDP growth for 2019-20 is revised downwards from7.2 per cent in the April policy to 7.0 per cent – in the range of 6.4-6.7 per cent for H1:2019-20 and 7.2-7.5 per cent for H2 – with risks evenly balanced.

23.The  MPC  notes  that  growth  impulses  have  weakened  significantly  as  reflected  in  a  further widening  of  the  output  gap  compared  to  the  April  2019  policy.  A  sharp  slowdown  in  investment  activity along with a continuing moderation in private consumption growth is a matter of concern. The headline  inflation  trajectory  remains  below  the  target  mandated  to  the  MPC  even  after  taking  into  account the expected transmission of the past two policy rate cuts. Hence, there is scope for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular, reinvigorate private investment activity, while remaining consistent with its flexible inflation targeting mandate.

24.Against  this  backdrop,  all  members  of  the  MPC  (Dr.  Chetan  Ghate,  Dr.  Pami  Dua,  Dr.  Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Shri Shaktikanta Das) unanimously  decided  to  reduce the  policy  repo  rate  by  25  basis  and  change  the  stance  of  monetary  policy from neutral to accommodative.

25.The minutes of the MPC’s meeting will be published by June 20, 2019.

26.The next meeting of the MPC is scheduled during August 5 to 7, 2019.