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Deconstructing RBI's Half Yearly View on the Indian Economy

Professor of Financial Economics and Part-time Value Investor, Transfin.
Oct 8, 2018 9:30 AM 3 min read

We all paid attention when RBI concluded its Monetary Policy Review last Friday, where it went against market sentiment to keep the repo rate flat. While minutes of the meeting are due to publish on Oct 19, another interesting document was released that day - the Central Bank's half yearly Monetary Policy Report. We present a short summary of the 84 page document throwing light on RBI's thinking with respect to the Indian Economy (using the report's headers and select excerpts): 


Macroeconomic Outlook: External environment remains challenging, adding to downside risk to India's growth. Food inflation muted to-date. Next 12m inflation expected to rise 'modestly' due to global volatility and rising crude oil.

Retaliatory trade protectionism, market volatility, rising crude oil prices ($15/bbl up between Apr-Aug), and tighter US rate environment are creating external headwinds on the Indian Economy. Weakness in other Emerging Markets adding to contagion. 


Domestic economic activity has demonstrated resilience. Inward FDI is strong. FPI outflows due to a depreciating Rupee (down 11.8% vs. USD since Mar). 


CPI inflation is projected to pick up from 3.7% in Aug to 3.9% in Q3:2018-19 and 4.5% in Q4:2018-19, with risks tilted to the upside. 


In the Sep round of the RBI survey, professional forecasters expected real GDP growth to decelerate from 8.2% in Q1:2018-19 to 6.9% in Q4 and then recover to 7.4% in Q2:2019-20.


Prices and Costs: Inflation has eased in Q2 due to an unusual calming in the momentum of food prices. Input costs rose sharply in Q1 and remained firm in Q2 due to increase in fuel prices. Wage pressures remained contained.

Actual inflation outcomes have tracked RBI projections directionally; however, in terms of magnitude, inflation undershot projections by a significant margin – 28 bps in Q1 and 74bps in Q2 till August - primarily due to a below expected increase in fruit and vegetable prices. Calming food inflation more than offset the impact of higher than projected crude oil prices in H1. 


Rural wage growth remain subdued since Aug, showing lagged impact of low inflation in the previous few months.


Demand and Output: Private consumption and investment demand strengthen. Robust increase in non-oil merchandise exports. Supply conditions improve with sharp acceleration in manufacturing, resilience in agriculture etc. Raising real investment activity consistently key.

Rapid catch-up in sowing activity, ample reservoir storage improves outlook for agriculture and allied activities on top of record production in 2017-18. Industrial activity has strengthened driven by manufacturing. Services sector is resilient.


Gross Fixed Capital Formation (GFCF) has decelerated due to the slowdown in investment in the private sector, weighed down by high leverage. However, the corporate sector has been deleveraging since H2, especially in manufacturing where interest coverage ratios have lately improved. Interest coverage ratios in Services are on their way down. Recent data on investment activity i.e. sales growth, capacity utilisation, inventory drawdown, and gradually returning pricing power suggest that the investment cycle has turned.


Tax revenues for Apr-Aug have grown by 7.5%, driven by higher income tax collections. The overall indirect tax base has expanded.


Financial Markets and Liquidity Conditions: Money markets are experiencing liquidity swings, G-secs and FX markets are affected by global factors. Stock markets gain considerable buying support from domestic mutual funds. Bank lending picking traction.

Consequent to default by IL&FS on September 14, 2018, the weighted average discount rate on Commercial Paper increased in general, and that for non banking financial companies (NBFCs), in particular. 


The G-sec yield curve has undergone level shifts in H1 in response to global spillovers as well as domestic factors such as near-term inflation outlook and monetary policy measures.


Overall NPA ratio of banks moderated in Jun vs. Mar end. NPAs in Personal loans and agricultural loans are deteriorating, where large credit flows have gone in recently. NPAs in Industry and Services loans have dipped in Jun vs. Mar.


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