Fourth Bi-monthly policy October 2019 Highlights

Dovish view with inclination towards further rate cuts going forward.

Key Points

  • Policy repo rate reduced by 25 bps to 5.15%, reverse repo at 4.90% and MSF at 5.40%
  • Monetary Policy stance remains “Accommodative – As long as it is necessary to revive growth, while ensuring that inflation remains within target”.
  • CPI inflation projected at 3.4% for Q2:FY20 and 3.5-3.7% for H2:FY20, with risks evenly balanced.
  • GDP growth forecast reduced to 6.1% from 6.9% in FY 19-20, and in the range of 6.6-7.2% for H2:2019-20 with risks evenly balanced.
  • Liquidity to be Neutral-Positive.

Inflation

Retail inflation remained in a narrow range of 3.1-3.2% between June & August, driven by food inflation, even as fuel inflation and CPI inflation excluding food & fuel moderated.

Factors shaping inflation path- 

  • With above average monsoon, Kharif production is estimated at close to last year’s level, auguring well for the overall food supply situation.
  • RBIs forward looking survey point to weak demand conditions, with indications of softening of output prices in Q3:2019-20.
  • Geo-political uncertainties affecting oil prices may provide upside risks to the inflation outlook.
  • Three months and one year ahead inflation expectations of households polled by the Reserve Bank have risen
  • Currency depreciations in several emerging economies.

Liquidity

  • Liquidity in the system was in surplus in August-September 2019 despite expansion of currency in circulation and forex operations by the RBI draining liquidity from the system.
  • Reflecting easy liquidity conditions, the weighted average call rate (WACR) traded below the policy repo rate (on an average) by 8 bps in August and by 6 bps in September.

Current Account Deficit and Forex

  • Trade deficit narrowed during July-August 2019. Higher net services receipts and private transfer receipts helped contain the current account deficit to 2% of GDP in Q1:2019-20.
  • On the financing side, net foreign direct investment rose to US$ 17.7 billion in April-July 2019 from US$ 11.4 billion a year ago.
  • India’s foreign exchange reserves were at US$ 434.6 billion on October 1, 2019 – an increase of US$ 21.7 billion over end-March 2019.

Domestic Growth outlook cut to 6.1%

  • Growth in GDP slumped to 5% in Q1:2019-20, extending a sequential deceleration to the 5th consecutive quarter.
  • Real GDP growth for 2019-20 is revised downwards from 6.9% in the August policy to 6.1% – in the range of 5.3% in Q2:2019-20 and in the range of 6.6-7.2% for H2:2019-20 with risks evenly balanced.

Factors that will influence growth

  • Various high frequency indicators suggest that domestic demand conditions have remained weak.
  • The business expectations index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q3.
  • Export prospects have been impacted by slowing global growth and continuing trade tensions.
  • Impact of monetary policy easing since February 2019 is gradually expected to feed into the real economy and boost demand.
  • Several measures announced by the Government over the last two months are expected to revive sentiment and spur domestic demand, especially private consumption.

Assessment of Global Growth

  • Global economic activity has slowed down since the meeting of the MPC in August 2019, amidst elevated trade tensions and geo-political uncertainty. The Institute for Supply Management’s index for September indicates that manufacturing slipped further into contraction to touch its lowest reading in a decade
  • Economic activity remained weak in major emerging market economies, pulled down mainly by a deteriorating global environment in Q3.
  • Crude oil prices were pulled down by softer demand, amidst adequate supplies in early August. Prices remained range bound until mid-September when supply disruptions on account of an escalating geo-political conflict resulted in a spike which has abated faster than expected
  • Gold prices remained elevated on safe haven demand.
  • Central banks became more accommodative with inflation remaining below targets across major AEs and EMEs

MPC voted 5-1 in favour of cutting Repo rate by 25 bps, while 1 member (Dr. Ravindra Dholakia) voted to reduce the policy repo rate by 40 bps.

Other Key Announcement

  • RBI Increase the household income limit for borrowers of NBFC-MFIs from the current level of Rs. 1 lakh for rural areas and INR 1.60 lakh for urban/semi urban areas to INR 1.25 lakh and INR 2.00 lakh, respectively. Raise the lending limit from INR 1.00 lakh to INR 1.25 lakh per eligible borrower.
  • Reserve bank have allowed banks to freely offer foreign exchange prices to non-residents at all times, out of their Indian books. Also, rupee derivatives (with settlement in foreign currency) to be traded in International Financial Services Centres.

Debt Market View

  • RBI reduced policy rate by 25 basis points from 5.40% to 5.15% and maintained its stance at “Accommodative” in order to strengthen domestic growth impulses by spurring private investment which has remained sluggish.
  • Growth is faltering, Inflation is comfortably below the RBIs target, Brent crude prices are in a comfortable zone and Liquidity continues to be in surplus zone.
  • Global central banks are increasing moving towards dovish stance.
  • With tax forgone because of Corporate tax cut, Fiscal deficit target remains a challenge. Lower GST and Direct tax collections also pose threat in achieving Fiscal target
  • High Real-rates continue to make debt an attractive asset class
  • We suggest products having maturity close to investment horizon having highest credit quality and lowest expense for investors having less than 1-year time horizon.
  • For a 3-year investor, we recommend allocation in 1-5-year average maturity segment with high credit quality portfolios mainly focused on accrual. The high-quality PSU and corporate bond spread over G-Sec is attractive
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Monthly Commentary September 2019

Growth

  • The Finance Minister, SLASHED corporate tax rate by 10% –effective tax rate currently stands at 25.17%, inclusive of surcharge and cess. 15% tax rate for new manufacturing companies.
  • Manufacturing PMI slipped to 51.4 in August, it’s lowest mark since May 2018. Services PMI also slowed to 52.4 in August from 53.8 in July.
  • The growth of eight core infrastructure industries slowed down to 2.1% in July 2019 as compared to 7.3% in the same month a year ago.
  • Snapping two-month declining trend, IIP stood at 4.3% in July 2019.
  • Indian automobile industry sales fell for 10th straight month in August.

Fiscal Position

  • Fiscal deficit touched Rs 5.47 lakh crore in the first four months (April-July) of FY20, which is 77.8% of the Budget Estimate.
  • The government’s total direct tax collection was only 4.7% more so far in FY20 as against a steep 17.5% higher tax collection budgeted for the full year.. August GST collection stood at Rs. 98, 202 Crs.

Inflation

  • CPI increased marginally to 3.21% in August from 3.15% in July, WPI remained unchanged at 1.08% in the month of August.

Global

  • MSCI World and MSCI Emerging both indices were up 1.73% and 1.74% respectively.
  • China’s official manufacturing PMI fell to 49.5 in August from 49.7 in July, while non-manufacturing PMI rose to 53.8 in August from 53.7 in July.
  • The PBOC cuts the reserve requirement ratio by 50 bps points for all banks, with an additional 100 bps cut for qualified city commercial banks.
  • ECB slashed the deposit rate by 10 basis points to -0.50%, while it left the main refinancing rate and the marginal lending rate unchanged at 0% and 0.25%, respectively; governing council approves purchases of debt at 20 bn euros a month starting November 1.
  • US Federal Reserve cuts the target interest rate by 25 bps to a range of 1.75-2% but gives mixed signals about its future course of action.
  • OECD says the global economy will see its weakest growth since the 2008-2009 financial crisis this year, slowing from 3.6% last year to 2.9% this year before a predicted 3.0% in 2020.
  • BoE’s Monetary Policy Committee all voted to keep rates on hold at 0.75% and reiterated a warning that leaving the EU without a deal would slow growth and raise prices.

Equity Outlook

  • Weak GDP data weighted on domestic risk sentiments early in the month. However, signs of easing US-China trade tensions, aggressive stimulus from the ECB, and rate cut hopes from RBI boosted sentiments. Strong up-move was triggered by government’s announcement of cut in corporate tax rates. Both Sensex and Nifty, settled at two-month high. Both the indices registered their biggest single day gains in 10 years on 20th September 2019
  • With strong Fiscal support in the form of Corporate Tax rate cut should help revive animal spirits back. But, impact of this on bond yields and translation of tax cut into higher sales and profits needs to be watched. Hence, we continue to maintain our stance of having large cap (According SEBI classification Focused and Multicap schemes having large cap bias) schemes over Midcap and small cap schemes as anchor of the portfolio. We had recommended reducing Mid & Small Cap exposure last year. Investors should reallocate to this segment as Mid and Small cap segment have corrected meaningfully and on Valuations they are now at a discount to Large caps.

Debt Market outlook

  • 10-year Benchmark 7.26% GOI 2029 increased 14 bps to close at 6.70% in the month of September. After FMs policy announcements, bond market had a sell off, it was a knee jerk reaction to the implications of revenue loss arising out of tax reductions.  As per initial estimates by the government, the possible revenue loss to the government would be roughly Rs. 1.45 lakh crore per year. Fall in Crude oil prices, fall in US treasury yields restricted rising yields. Bond markets are awaiting for Monetary policy and Second half borrowing calendar.
  • For a 3-year investor, we recommend allocation in 1-5-year average maturity segment with high credit quality portfolios mainly focused on accrual. The high-quality PSU and corporate bond spread over G-Sec is attractive.