What Does the RBI's Latest Assessment of the Indian Economy Say?

Dec 7, 2017

Last Friday, I revealed the findings of Vivek Kaul's Indian Economic Thermometer for the July-September quarter. Vivek's indicators showed that the economy did better during the September quarter than the June quarter. So yes, it seems there's some recovery. But does it indicate a clear revival? Well, this is something to watch out for in the coming quarters.

Yesterday, the RBI's Monetary Policy Committee (MPC) announced its fifth bi-monthly monetary policy statement. Unsurprisingly, the RBI made no changes to any policy rates.

It retained the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.0%. The reverse repo rate under the LAF remains at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate at 6.25%. (If the financial jargon seems overwhelming, I would suggest you read my earlier note on the RBI's monetary policy statement in August 2017.)

How Did the Stock Markets React?

Yesterday, both BSE Sensex and NSE Nifty indices closed lower by 0.6% and 0.7%, respectively. But I believe the market decline yesterday cannot be attributed to the RBI's status quo on policy rates. It wasn't an unexpected stance.

And if you noticed, the markets have been nervous recently. The Sensex has been sliding lower after it scaled close to its all-time high in the last week of November. Today, however, there has been a strong bounce back and the Sensex is up 1.1%.

Let's look at the MPC's assessment and outlook for the economy. I'll take you through some key excerpts...

Indian Economy in July-September quarter...

  • On the domestic front, the growth of real gross value added (GVA*) accelerated sequentially in Q2 of 2017-18, after five consecutive quarters of deceleration. It was powered by a sharp acceleration in industrial activity.

(*Gross value added (GVA) is a productivity metric. At the country level, GVA is the output of the country less the intermediate consumption. It is used in the calculation of gross domestic product (GDP)).

  • All the three sub-sectors of industry registered higher growth. GVA growth in the manufacturing sector - the key component of industry - accelerated sharply on improved demand and re-stocking post goods and services tax (GST) implementation.

    In contrast, growth in agriculture and allied activities slackened, reflecting the lower than expected kharif harvest.

    Activity in the services sector decelerated, mainly on account of slowdown in financial, insurance, real estate and professional services, and in public administration, defence and other services (PADO) following the large front-loading of government expenditure in Q1.

    Despite some improvement, construction sector growth remained tepid due to transitory effects of the RERA and GST implementation. Growth in the trade, hotels, transport and communication sub-group remained resilient, in spite of some slowdown in growth in Q2 as compared with the previous quarter.

    On the expenditure side, the growth of gross fixed capital formation improved for the second successive quarter. However, growth in private final consumption expenditure - the mainstay of aggregate demand - slowed to an eight-quarter low in Q2.

Indian Economy in the ongoing quarter (October-December 2017)...

  • Available high-frequency indicators suggest a mixed picture of industrial activity for Q3. Core industries' growth was flat in October as all constituents barring steel and fertilisers slowed down sequentially. Coal mining, which revived strongly in Q2, slowed down too, while cement production contracted.

    In contrast, the Purchasing Managers' Index (PMI) for manufacturing, which fell in October, rebounded in November, driven by output and new orders. Also, according to the Reserve Bank's Industrial Outlook Survey (IOS), production is expected to pick up in Q3 as order books are rising.

    Services sector activity has remained mixed in October. In the transportation sector, sales of commercial vehicles decelerated; those of passenger vehicles and two-wheeler turned into contraction mode. By contrast, domestic and international air passenger and freight traffic, and railway freight expanded robustly. The Reserve Bank's survey suggests that sentiments on service sector activity for Q3 are upbeat and auto sales have rebounded in November. On the other hand, PMI for services moved into contraction zone in November.

On Exports and Imports...

  • Merchandise exports declined by 1.1% in October 2017 after showing positive growth for 14 consecutive months. A sustained increase in exports of engineering goods, petroleum products and chemicals during the month was outweighed by a sharp fall in shipments of gems and jewellery, ready-made garments, and drugs and pharmaceuticals.

    Imports continued to expand, though at a modest pace. Although gold imports rose sequentially in October, they moderated from their level a year ago. Consequently, the trade deficit widened again in October.

    Despite moderation in September, net foreign direct investment in H1 of 2017-18 was at the same level as a year ago. With the announcement of the recapitalisation plan for public sector banks, foreign portfolio inflows into equities resumed sharply in October, after recording outflows in the preceding month. India's foreign exchange reserves were at US$ 401.94 billion on November 30, 2017.

Inflation Assessment and Outlook...

  • Retail inflation measured by year-on-year change in the consumer price index (CPI) recorded a seven-month high in October.

    Two of the key factors determining the cost of living conditions and inflation expectations, i.e., food and fuel inflation, edged up in November.

    The Reserve Bank's survey of households showed inflation expectations firming up in the latest round for both three months ahead and one year ahead horizons.

    Going forward, the inflation path will be influenced by several factors....

    ...the recent rise in international crude oil prices may sustain, especially on account of the OPEC's decision to maintain production cuts through next year. In such a scenario, any adverse supply shock due to geo-political developments could push up prices even further.

    The GST Council in its last meeting has brought several retail goods and services to lower tax brackets, which should translate into lower retail prices, going forward.

    On the whole, inflation is estimated in the range 4.3-4.7% in Q3 and Q4 of this year.

Economy Outlook...

  • Turning to GVA projections, Q2 growth was lower than that projected in the October resolution. The recent increase in oil prices may have a negative impact on margins of firms and GVA growth. The projection of real GVA growth for 2017-18 of the October resolution at 6.7% has been retained.

Happy Investing,


Ankit Shah (Research Analyst)
Editor, Equitymaster Insider

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