Growth indicators

GDP data for 4QFY19 pointed to continued weakening in growth momentum in the quarter. 4Q Gross Value Added (GVA) and GDP came at 5.7% (6.3%) and 5.8% (6.6%) respectively, which were lower than the market consensus. Note that part of reason for very low y-y growth numbers was also due to adverse base of 0.6% over previous quarter, which is same as growth slowdown from previous quarter.

If we look at m-m growth trend, number looks less disappointing.

The decline was led by manufacturing (which was expected) and agriculture (which was a negative surprise for markets). Though manufacturing weakness was expected, agriculture came quite low at -0.1%, though partially over very high base and reflects some disappointment in rabi foodgrain output and probably weaker output of horticulture and animal husbandry. The same may also be reflecting in some uptick in food prices, though with abundant buffer this should not be a problem now. There was strong growth in services which was dominated by financial services, reflecting strong growth in bank credit/deposit as well as good profitability numbers by banks, and healthy growth in government expenditure as well. Weak growth in Trade hotel transport reflected overall weakness in industry and consumption.

With high frequency indicators still weak, June quarter GDP growth will also likely come on the softer side though there will likely be a post-election boost and spending boost by government in June.

One can argue that if the new government can rekindle positive sentiments, market interest rates come down and there is some easing out of NBFC stress then we may be on the verge of trough of GDP growth sometime in May. There will anyway be a pop in growth once activities stalled due to election re-start. However, global sentiments remain an overhang and a proper reversal in growth will require support from global risk sentiments. If there is global panic, then growth uptick will take longer.

External trade

Trade deficit for April increased to 15.3 bn against 10.9 bn in March. The rise in trade deficit was due to seasonality, weakness in exports and rise in gold imports. Weakness continued in imports of electronics items (there was a small y-y uptick) as well as machinery items. Imports of steel, coal and chemicals is holding up. Exports weakened after strong growth in March. Strong uptick in exports of machinery in March reversed in April. Growth remained decent in chemicals but was weak in agriculture, textiles and leather. Notably Indian trade has largely moved in sync with global trade. The escalation of US-China trade tensions would likely to continue putting pressure on world trade, which shall have a fallout on Indian trade as well. At current run-rate, we are looking at CAD at ~2.2 to 2.5% of GDP range, which should be comfortably funded by capital inflows if global environment remains OK.

Inflation

April inflation rose marginally to 2.92% but remained broadly in sync with RBI forecasted 2.9-3% inflation in 1H FY20. In terms of breakdown, April inflation was a continuation of March inflation number with further uptick in food inflation and cooling of core inflation. The divergence between rural/urban inflation remained elevated with urban inflation rising to 4.2% and rural inflation at 1.9%. The high rural-urban divergence continues to surprise and could be data issue and should converge. Within the food segment, the pickup was largely led by higher vegetables, followed by meat & fish, pulses & products among others. Vegetable inflation turned positive after 9 consecutive months of negative reading. Core inflation decline was quite broad-based, and inflation eased in most segments. M-m momentum also eased across the broad. Going ahead we see some upside risk to RBI's forecast of inflation in 1H due to possible upside in food inflation.

Other developments

RBI June August policy turned out to be more dovish compared to market expectations with a 25bp rate cut and stance change to accommodative, both with 6-0 vote. The tone of the policy was quite dovish and clearly highlighted growth concerns. The MPC noted that growth impulses have weakened significantly as reflected in a further widening of the output gap vs. the previous policy. RBI also assured market of adequate liquidity in the system. While refusing to commit to any specific policy action on the NBFC stress, RBI stated that it is very closely monitoring the situation and will ensure well-functioning of the NBFC sector and stability of the financial system.

Moreover, in a subtle, but far reaching change, RBI has moved from commitment to 4% durable inflation earlier, to accommodate growth concerns while remaining consistent to flexible inflation targeting. This change suggest shift from 4% inflation target to 2 to 6% range as the inflation target. With today's policy, RBI has done a cumulative 75 bp rate cut in three consecutive monetary policy meetings and repo rate are now at lowest level since September 2010. However, we believe there is scope for further rate cuts unless there is growth rebound or material risk to inflation outlook. Our base case would be of a rate cut in August policy. While we see some upside risk to RBI's inflation forecast for 1H, the stress in NBFC sector and global growth concerns mean that growth will need more help from the monetary policy.

Portfolio Positioning

Thus, with change in RBI stance to "accommodative", possibility of further rate cuts & revisiting the exiting liquidity framework by RBI over next two month, focus now shifts to effective policy transmission and support growth till inflation remains within target range. This is like a game changer for shorter end of the curve upto 3years, which still are quite lucrative from spreads basis especially for AAA corporate bonds. Also, with new MTM guidelines for mutual funds in place from June 2019, it is likely that liquid funds may underperform other debt categories by reasonable margins on account of high reinvestment risk and surplus liquidity regime.

CAD: Current account deficit

Source: CEIC, Bloomberg, RBI

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