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Event update: RBI Monetary Policy (Dec-19) - MPC maintains repo rate on inflation concerns

MPC decided to maintain repo rate at 5.15% and retain accommodative stance in a unanimous vote. This decision was in line with IDFC expectations owing to growth-inflation conundrum and growing fiscal concerns (details ). Consensus, however, was expecting a 25bp rate cut and thus, this outcome took 10 year yields by surprise. Going forward, we expect outcome for next meeting MPC meeting to be data dependent. MPC will meet next in February, by then, we will have clarity on fiscal path (budget on 1^st Feb) and food prices trajectory. In terms of growth, we believe that already executed 135bp rate cut is indeed significant and will continue to support growth, but marginal utility of incremental rate cuts continues to come off. Hence, fiscal stimulus by way government spending, is the way forward. Consequently, we expect fiscal deficit to settle in between 3.5%-3.8% of GDP, depending upon how disinvestment pans out. We also expect 10 year yields to be sticky and go up to 6.7% over next two months, on fiscal concerns.  This will also lend some steepening bias to yield curve. Inflation and fiscal deficit would be key data points to be monitored over next two months and their trajectory will dictate the movement in 10 year yields.

Key take-aways from the policy statement:

• Inflation-growth conundrum is the primary reason behind pause: MPC mentioned that current inflation growth dynamics as a primary reason behind the pause as headline inflation shot up to 4.6%yoy, which is the key focus area for MPC. This is further aggravated by weak growth which is leading core inflation downwards for last 16 months, thus presenting difficult choice in front of MPC. Also, we believe that RBI will want to wait up till upcoming budget to see how fiscal maths pans out.
• While broad weakness in growth persists, there are early green shoots, sustainability of which needs to be ascertained: MPC statement indicated that output gap in the economy continues to be negative and majority of broad indicators like core industries, IIP, sentiment in manufacturing sector etc continue to deteriorate further. Overall capacity utilisation also fell to 68.9% in Q2FY20 from 73.6% in Q1FY20. However, there have been green shoots, for which sustainability needs to be ascertained. Few positives highlighted by MPC were: a) Rabi sowing catching up and is only down 0.5%yoy as of 29^th Nov (though on a low base), b) Uptick in services PMI at 52.7 in November against 49.2 in October, c) early signs of recovery in investment activity as indicated by corporate finance and projects sanctioned data.
• While various money market segments have seen full monetary transmission, deposits and fresh loans have seen significantly lower transmission: With 135bp cut in repo rate, various money market and corporate debt segments have seen rates coming down by 137-218bps. Government securities have however seen weak transmission with 113bps down move in 5 years securities and 89bps for 10 year securities. However, cumulative deposit rate decline has been just 16bps since Feb-19, which poses a big challenge to credit off-take in our view. WALR on fresh loans is also down mere 44bps.
• GDP growth forecasts continue to see a downgrade: Owing to overall weakness in economic backdrop, FY20 growth forecast was downgraded to 5% from 6.1% earlier. H2FY20 is expected to see 5.2% yoy growth, against 6.9% expected earlier. Also H2FY21 GDP growth is now expected to settle at 6.1%.
• CPI forecast revised upwards: Q2 CPI forecast revised upwards to 4.9% for H2FY20 against 3.6% earlier. H1FY21 inflation expectations are now at 3.9% against 3.6% expected in Q1FY21 earlier.
• MPC reiterated that there is space for further cuts, in case further intervention is needed at a later stage

·      Yields run up on as street expected a 25bp rate cut: The decision was against street expectations as consensus expected 25bp rate cut.  Yields went up 12.7bp to 6.59% after the announcement