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Event update: RBI Monetary Policy (Oct-19), Reinforcing demand resurrecting measures

Monetary Policy Committee’s (MPC) decision to cut repo rate by 25bp to 5.15% reinforces RBI’s accommodative stance to support growth revival. We expect RBI and government of India’s (GoI) growth stimulating measures to improve demand, going forward, especially private consumption. By advocating intensified measures to restore growth, RBI is leaning towards better demand than stressing over higher inflation. RBI’s assessment fortifies conviction on our pro-consumption theme.

Key takeaways from the monetary policy statement and other regulatory announcements:

• RBI cut FY20 growth forecast to 6.1% from 6.9% earlier. The central bank has slightly raised inflation forecast for Q2FY20 to 3.4% from 3.1% earlier.
• Low real GDP growth print of 5% in Q1FY20 implies widening negative output gap compared to potential growth.
• However, the positive thing is that seasonally adjusted capacity utilisation for the manufacturing sector at 74.8% in Q1FY20 is higher than 74.5% in Q4FY19 (based on RBI’s measure).
• Regulatory easing to aid credit flows:

o Increase lending limit by NBFC-MFIs to Rs125,000/borrower from Rs100,000 earlier;

o Expanding the eligible borrower base for NBFC MFIs by increasing household income limit from Rs100,000 to Rs125,000 in rural areas and from Rs160,000 to Rs200,000 in urban areas,

o Easing regulations on offshore rupee markets (in line with Usha Thorat committee recommendations),

Outlook: Reflationary measures to improve demand, especially private consumption

MPC’s decision of 25bp rate cut to 5.15% reinforces RBI’s accommodative stance to support growth revival. The real repo rate at 80bp (i.e, repo rate of 5.1% less core inflation of 4.3%) is much lesser than the target of 1.5-2%.

GoI and RBI have put in place significant growth stimulating measures, which include cumulative 135bp repo rate cut, reduction in corporate tax rate, push towards accelerated monetary and rate transmission to lower lending rate, measures to improve lending (retail, MSME, and micro finance), and revival in government spending.

Overall, RBI’s scaling down of real GDP growth projection to 6.1% for FY20E from 6.9% is to align with the weak 5.0% print for Q1FY20. The future trajectory however, is an improving one, rising to 5.3% in Q2FY20E, 6.6-7.2% in H2FY20E and 7.4% in Q1FY21E. Hence, with progress in various stimuli, real GDP should rise by 240bp between Q1FY20E and Q1FY21E, in our view. The counter-cyclical easing measures should improve consumption demand and investment sentiment, especially private consumption.

Improved demand will also imply higher inflation. While RBI has scaled up headline CPI inflation to 3.4% in Q2FY20 from 3.1% earlier, the overall assessment remains benign, with inflation projected to rise gradually to 3.6% in Q4FY21E. Of the various factors cited by RBI, upside risk could come from a) higher food prices, b) rise household inflation expectation, c) geo-political spill over impact on global crude prices, and d) INR/USD weakening. Downside risk to inflation arise from a) good monsoon, and b) steady core inflation.

In sum, RBI’s assessment fortifies our outlook of better growth over next 4-6 quarters, pivoted on improvement in consumption demand.