The Monetary Policy Review delivered no surprises, and that disappointed the stock market a little as optimists were looking for a rate cut. The central bank continued to speak of "calibrated tightening" but it will continue to inject liquidity through open market operations, by conducting bond buybacks. The SLR is also due for a cut in January. One negative for banks is the proposal that they must link floating rates to external benchmarks. Banks will, therefore, lose the leeway to fatten spreads on new mortgages.
The MPC forecasts inflation to remain subdued and sees some downside risks to growth. This is partly due to the possibility of a global slowdown, and because base effect dissipation will lower growth rates. But there is also fear of lower consumption demand, especially lower rural demand. The RBI estimates that the output gap has been nearly closed, with capacity utilisation now running above the long-term average. However, growth projections have not been changed. This is in contrast to international rating agencies and brokerages, which have cut projections for the second half.
The statement points out that core inflation (ex fuel, ex-food) remains sticky at around 6 per cent. Another source of concern is that food prices could start rising again, given sub-normal rabi sowing. Nevertheless, the projections suggest that inflation will stay at 4 per cent or lower.
On the global front, one estimate is that energy fuels will remain moderately priced, while commodities - namely industrial metals - could continue sliding as global growth slows. EME currencies (including the rupee) have strengthened and could possibly strengthen further.
The OPEC meeting this weekend will have some consequences for the energy market, if Saudi Arabia can push through production cuts. This poses a possible upside risk to crude prices. In addition, there is likely to be a phase of liquidity tightening for the dollar and the euro. The Fed is committed to further rate hikes and quantitative tightening while the European Central Bank should cut back on its Quantitative Easing (QE) programme.
These central bank decisions will be known over the next fortnight and could lead to a re-assessment of critical external variables. Of course, Brexit — if it happens — could lead to the ECB continuing with its QE at the current volume. It's also possible that a slowdown in US growth will lead to the Fed putting a pause on its rate hike schedule.
Making a call on the outcome of the trade war is more difficult, since that involves negotiations over several months. It obviously has a bearing on global growth as well as US inflation, which in turn feed into the Fed's forward projections.
The future direction of sanctions on Iran is also difficult to factor in - will the US allow Iranian crude exports to continue to specific nations, including India, China and Japan?
The stock market reacted down. The forex market did not react much, with rates remaining stable. The bond market will need to absorb the MPC's emphasis that fiscal discipline is critical before it is prepared to cut rates.
Given the fiscal deficit has already crossed the full-year Budget Estimate and that it's an election year, reining in of government expenditure is unlikely. That means yields could stay high, on account of government borrowing. High government debt issuance will continue to crowd out private sector borrowings.
The review, therefore, changes little in the way of fundamental perceptions. It's a wait-and-watch situation, where we can hope to receive some clarity on global developments over the next three weeks. Most domestic investors will continue to focus on political news flow in an attempt to make sense of the likely shape of the next central government.