Policy rates are not changed
In view of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting held on February 6, 2020 decided not to change the applicable policy repo and reverse-repo rates under the liquidity adjustment facility (LAF) and the marginal standing facility (MSF) rate and the Bank Rate and so they continue to remain at their existing levels at 5.15 per cent, 4.90 per cent and 5.40 per cent respectively.
The policy asserts that it has continued its accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
Global economy remained subdued
On the global front, the pace of growth remained slow or stagnant in the US, France, Italy, UK, Japan, China, Russia, Brazil, South Africa and in many countries spending remained subdued amidst prolonged consumer pessimism.
Secondly, due to rising geo-political tensions, crude oil and gold prices shot up in early January. However, of late, crude oil prices dipped sharply due to sell-offs triggered by the outbreak of the coronavirus, which was source of another disruption.
Thirdly, inflation has gone up in major advanced economies and even emerging market economies due to rise in International food.
However, good thing is that the global financial markets are reported to have remained resilient in recent times as US-China trade relations seem to be softening and prospects of an orderly Brexit are seen as improved and so investors’ sentiment has been high by and large. Bond yields also softened across several countries.
All is not well in domestic economy
Talking about the domestic economy, the National Statistical Office (NSO) has projected a dismal 5.0 per cent growth for 2019-20 in real gross domestic product (GDP). Further, it reduced the real GDP growth for 2018-19 to 6.1 per cent from 6.8 per cent given in the provisional estimates of May 2019. On the supply side, growth of real gross value added (GVA) has been projected at 4.9 per cent in 2019-20 as compared with 6.0 per cent in 2018-19.
According to the monetary policy statement, production and import of capital goods has not picked up in the recent times which is an indicator of reduced investment sentiment. However, the government was able to keep the revenue expenditure at high levels in an attempt to give counter cyclical buffer to domestic demand for final consumption.
On the supply side, increase in rabi sowing by 9.5 per cent up to January 31, 2020 compared to last year coupled with more favourable north east monsoon, may lead to higher overall food production in this season.
On the other hand, the index of industrial production (IIP), improved in November after contracting in the previous three months and there were signs of improvement noticed in five out of eight core sectors. But the capacity utilisation in the manufacturing sector, as measured by the Reserve Bank’s order books, inventory and capacity utilisation survey (OBICUS), has reduced to 69.1 per cent in the second quarter from 73.6 per cent in the first quarter. This was corroborated by the findings of the Reserve Bank’s industrial outlook survey indicating weak demand conditions faced by the manufacturing sector in third quarter ending in December, 2019.
Things are getting better though
If we go by the Reserve Bank’s business expectations index, well it suggests an improvement in in this quarter. Even the manufacturing purchasing managers’ index (PMI) for January 2020 has improved to 55.3 from 51.2 in November 2019 on the back of increased output and new orders.
The monetary policy statement takes cognizance of positive trends for the services sector indicating some revival although it warns that the outlook is still muted. An improvement in the PMI services index has increaased to 55.5 in January 2020 from 52.7 in November 2019, boosted by a rise in new business and output.
Although increase in retail inflation from 4.6 per cent in October to 7.4 per cent in December 2019 has been the highest reading since July 2014, yet it was largely affected by an alarming increase in onion prices due to unseasonal rains in October and November. If we exclude food and fuel, CPI rose from a low of 3.4 per cent in October to 3.8 per cent by December 2019.
While the RBI’s consumer confidence survey suggests that consumer spending on nonessential items of consumption has been lower compared to the last year, yet the overall spending is expected to rise, and so the inflationary pressures may continue to build up in the short and medium terms. However, overall liquidity in the system remained in surplus in the recent months.
The introduction of the external benchmark system which required banks to link their lending rates for housing, personal and micro and small enterprises (MSEs) to the policy repo rate of the Reserve Bank has improved monetary transmission.
Although there was a decline in export growth due to slowdown in global trade and import growth too has fallen due to the underlying weakness in domestic demand yet on the financing side, there was an increase in the net foreign direct investment. The foreign portfolio investment also increased. External commercial borrowings were also at a higher level. The foreign exchange reserves increased to US$ 471.4 billion on February 4, 2020 from US$ 58.5 billion over end-March 2019.
Outlook seems to be good
According to the monetary policy statement it seems that the growth prospects may improve in the near- to medium-term. The Financial flows to the commercial sector have improved in recent months. The Union Budget 2020-21 has proposed a lot of measures to provide an impetus to growth. Particularly, the budget focus on boosting the rural economy and infrastructure may bring in improvement in growth in the short term while the corporate tax rate cuts of September 2019 may result in higher growth prospects in the medium-term.
Although the budget keeps the fiscal deficit under the prescribed limits and is poised to decline to 3.5 per cent of GDP for 2020-21 yet uncertainty about inflationary tendencies coupled with subdued economic activity remains to be a cause of concern.
To conclude, the Monetary policy Committee (MPC) opted for maintaining the status quo with the policy rates and continues its accommodative stance trying to balance its twin objective to revive growth, while ensuring that inflation remains within the target.
While the RBI has acted prudent not to increase the repo rates yet in my opinion it could have taken another tryst with rate cut, may be nominal say 15 basis points, in view of the present inflation/growth dynamics. Further, it could also have also strengthened the budgetary measures to give impetus to growth in the near- to medium-term.