The June monetary policy checked all the right boxes as far as markets expectations were concerned. The widely anticipated 25 bps cut was reinforced by a unanimous 6-0 verdict on the voting and a change in the stance to “accommodative". While this is the third consecutive rate cut, the voting pattern and stance change has helped to unequivocally convey an accommodative rate path, which assumes paramount importance against the backdrop of fragile domestic and global growth prospects. The accompanying statement and the post policy rhetoric indicated that rising growth concerns have clearly taken precedence over fears of inflation. The formation of a committee to examine the liquidity framework is an added positive.

On growth, the committee highlighted significant weakening of growth impulses, which led it to lower the gross domestic product (GDP) estimate to 7%. We concur with this assessment as our own diffusion index of high frequency indicators shows continued moderation in our estimates of monthly output gap for Q1 FY20. This comes on the back of a weaker than expected Q4 FY19 GDP reading of 5.8% y-o-y, which prompted us to downgrade our forecast for FY20 by 20bps to 7% y-o-y. While private consumption is moderating it has not yet shown any excessive signs of weakness and ongoing income schemes announced by the government and easing of financial conditions should help to stall a sharper fall. We remain concerned about the decline in investment activity. Core industry imports, freight traffic, and car sales continue to remain muted. Moreover, the risks from adverse external shocks in light of the worsening trade conflicts could detract further from domestic growth if not resolved soon.

On inflation, there are contrary forces operating through rising food prices and declining core inflation. If the balance of risks for global growth are tilted lower, then sharp increases in crude prices from here on are unlikely. Even with deficient monsoon leading to pressure on sowing, liquidation of stocks by the government could help reduce strain on prices. While fruits and vegetables could still continue their upward momentum, nimble supply management of other key items in the food basket could provide an upper bound to food inflation. On the other hand, core inflation is the closest proxy for growing slack in the economy and weakening growth prospects are likely to lead to further declines in core inflation. On balance, we expect CPI to average 3.9% YoY for FY20, which is comfortably within the MPC’s mandate.

A working group to review the liquidity framework will help lower the information asymmetry about the system’s perception of domestic liquidity and maybe also widen the scope of metrics used to determine strain in the system over and above the weighted average call rate. The report is due in July and will help markets but also in other banking-related decisions involving transmission and deposit and credit rates. However, given that India’s financial system has had to grapple with several credit events recently, more expeditious action on the liquidity framework would have had a more salutary impact. Given the change in stance and the firm focus on growth there is scope for at least one more rate cut in this cycle. The trajectory of global growth has to be factored into the monetary policy reaction function. However, the clarity on policy stance and benign global policy environment would help benchmark bond yields even test 6.8% as we go along with a trading range of 6.8-7.1% with some bull steepening of the curve. Subscriptions to bond auctions and propensity of state-run banks to add bonds to their portfolio need to be closely watched. On the rupee front, we expect a range of 68.50-71 level against the dollar in the near term as bullish flow sentiments could get capped by RBI’s concerns on the real effective exchange rate front.

B. Prasanna is group head-global markets (sales, trading and research) at ICICI Bank.

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