India’s Monetary Policy

India’s Monetary Policy Committee (MPC), in contrast to market expectations hiked policy interest rates (repo rate) by 25 bps to 6.25% in its meeting held on 6th Jun’18. The decision to raise rates was taken unanimously, with all six MPC members voting in favour of the decision. The move was surprising as majority of the market participants were expecting the RBI to maintain status quo. The Reserve Bank of India (RBI) though continued with its neutral policy stance, re-iterating its objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2 per cent, while supporting growth.

Exhibit 18: Monetary Policy

Source RBI

The RBI has revised marginally upward its inflation projection for 1HFY19 to 4.8% – 4.9% from its earlier projection of 4.7%-5.1%. It has raised its inflation projections for 2H to 4.7% from 4.4%. The RBI has maintained its FY19 GDP growth forecast at 7.4%. The RBI continues to highlight upside risks to inflation from 1) uncertainty owing to global financial market developments, 2) rising household inflation expectations 3) HRA revisions by state government 4) revision in Minimum Support Prices (MSP’s) and 5) potential for a benign monsoon.

We believe the RBI’s surprising move to hike rates could have either been to stem currency depreciation or mitigate the risk of rising core inflation. If this is the objective of the RBI, a 25bps hike may be insufficient and RBI may hike rates in the future assessing the situation on these two factors.


GDP Growth

India’s real gross domestic product (GDP) growth came in at 7.7% YoY during 4QFY18 (Year end, March), its fastest pace in seven quarters. The GDP numbers were higher than the market consensus of 7.4% YoY growth and up from 7.0% YoY growth in 3QFY18. Overall, real GDP grew 6.7% in FY18, the slowest pace in four years.

The pick-up in GDP growth during 4QFY18 was mainly driven by investments (+14.3% YoY v/s 13.0% in 3QFY18), which rose at the fastest pace in 24 quarters. The growth though was also aided by a favourable base as investments grew just 1.1% in 4QFY17 post demonetisation. Consumption growth improved to a three-quarter high of 8.1%, aided by 16.9% growth in government spending.  While imports surged by 10.9% YoY, export growth was sluggish at 3.6%. As a result, net exports dragged down GDP growth by 1.5% in 4QFY18. The construction and manufacturing sector saw sharp improvement during the quarter. Construction activities rose by 11.5% YoY in 4QFY18, up from 6.8% YoY in 3QFY18, this was the fastest pace of its growth in six years. Manufacturing growth touched a seven-quarter high of 9.1% in 4QFY18 (3QFY18: +8.1%), growth in services was steady at 7.7%.

Exhibit 19: Contributors to GDP Growth in 4QFY18

Source: MOSPI, Government of India

The latest GDP release signals that India’s economy is on a recovery path supported by the ongoing recovery in rural economy, improvement in consumption demand, Government’s consumption expenditure, infrastructure spend and industrial capex recovery. The fact that the GDP growth is gradually transitioning from consumption driven to investment led is a long-term positive. This transition forms the base for growth to move to its next trajectory.

In the near term though, widening of trade deficit due to slower export momentum, increase in fiscal deficit, hardening of core inflation and domestic currency depreciation pose risks to growth. Government’s spending ability has moderated, having breached the fiscal deficit target in FY18. This may in turn lower the contribution of government spending to real GDP going forward. However, consumption demand and private capex recovery should support growth. This implies that GDP growth will potentially remain below 7% for the second consecutive year in FY19.