Monetary Policy Report

Monetary policy report * OCTOBER 2019
I. Macroeconomic Outlook attack on Saudi Arabian oil facilities and disruption
to global oil supplies.
The slowdown in domestic economic activity that Domestically, the slowdown in economic activity
started in 2018-19 extended into the first half of 2019- that started in 2018-19 extended into the first half
20. Headline consumer price index (CPI) inflation of 2019-20. Real GDP growth fell to a 25-quarter low
is projected to remain below target over the rest of in Q1:2019-20 on weak private consumption and
2019-20 and the early months of 2020-21. Real gross investment and high frequency indicators for Q2
domestic product (GDP) growth is expected to recover point to a slowdown in the various constituents of
in H2:2019-20, facilitated by favourable base effects aggregate demand deepening. Some green shoots are
and transmission of past monetary policy actions. A emerging though in agriculture and allied activities.
slew of measures by the government impart an upside to The initial delay and deficiency in the south-west
growth prospects. Intensification of global uncertainty monsoon has been mitigated by the resurgence of
around US-China trade tensions, a hard Brexit and rains during July-September. Comfortable reservoir
levels augur well for rabi sowing and foodgrains
geo-political tensions are key downside risks to the
stocks above the buffer norms provide a cushion
baseline growth path.
against potential inflationary pressures. Meanwhile,
I.1 Key Developments since April 2019 MPR headline CPI inflation remains below target. While
food inflation has edged up since March 2019,
Since the release of the Monetary Policy Report (MPR)
inflation excluding food and fuel has undergone a
of April 2019, global economic activity has weakened
broad-based moderation.
further. Several downside risks flagged in the April
MPR appear to be materialising: escalation of trade Monetary Policy Committee: April-August 2019
tensions; growing probability of a disorderly Brexit; During April-August 2019, the Monetary Policy
volatility in crude oil prices; and a risk-on risk-off Committee (MPC) met thrice in accordance with
sentiment in financial markets on tumultuous geo-
the bi-monthly schedule. In the April meeting, the
political and economic events. In their wake, global
MPC cut the repo rate by 25 basis points (bps) to 6.0
growth has lost the momentum it had gathered in
per cent (with a majority vote of 4-2) to strengthen
Q1:2019. Central banks across advanced economies
domestic growth impulses by spurring private
(AEs) and emerging market economies (EMEs) are
investment, while maintaining a neutral stance (with
easing monetary policy in counter-cyclical defence.
a majority vote of 5-1). With signs of weakening of
Global trade has sunk into contraction, with knock-
growth impulses even further widening the negative
on effects impacting investment and industrial
output gap, and with headline inflation projected to
production, especially manufacturing. Reflecting
remain below the target over the next 12 months,
this, commodity prices slumped, with crude oil
the MPC voted unanimously to reduce the repo
prices tumbling in August and gold prices surging
rate by another 25 bps in its June 2019 meeting and
on safe haven demand. Foreign exchange markets
changed the stance of monetary policy from neutral
turned volatile, following the depreciation of the
to accommodative.
Chinese renminbi in early August. Crude oil prices
were bolstered temporarily in mid-September by the In its August meeting, the MPC reduced the policy
repo rate by a further 35 bps to 5.40 per cent on
*
Released on October 04, 2019. signs of accentuation of the slowdown in domestic
RBI Bulletin October 2019 9

Monetary policy report OCTOBER 2019
activity amidst deteriorating global growth and

Table I.2: Baseline Assumptions for Near-Term
escalating trade tensions posing downside risks to Projections
the outlook. With the inflation outlook projected Indicator MPR (April 2019) Current MPR
(October 2019)
to be benign and within the target over the forecast
Crude oil (Indian US$ 67.0 per barrel US$ 62.6 per barrel
horizon, all members of the MPC voted unanimously basket) during 2019-20
to reduce the policy rate (4 members for a reduction Exchange rate ₹69/US$ ₹71.3/US$
of 35 bps and two for 25 bps) and to maintain an Monsoon Normal for 2019 10 per cent above long
period average
accommodative stance. The MPC was of the view
Global growth 3.5 per cent in 2019 3.2 per cent in 2019
that the standard 25 bps cut might prove to be 3.6 per cent in 2020 3.5 per cent in 2020
inadequate in view of evolving global and domestic Fiscal deficit (per cent To remain within BE To remain within BE
macroeconomic developments, while a 50 bps of GDP) 2019-20 2019-20
Centre: 3.4 Centre: 3.3
reduction might be excessive, especially taking into Combined: 5.9 Combined: 5.9
account the actions already undertaken. Overall, the Domestic No major change No major change
macroeconomic/
MPC reduced the policy repo rate by a cumulative 85 structural policies
during the forecast
bps during April-August, in addition to the reduction period
of 25 bps in February. Notes:
1. The Indian basket of crude oil represents a derived numeraire
The MPC’s voting pattern reflects the diversity in comprising sour grade (Oman and Dubai average) and sweet grade
(Brent) crude oil.
individual members’ assessments, expectations 2. The exchange rate path assumed here is for generating staff’s
and policy preferences, a feature that is reflected in baseline growth and inflation projections and does not indicate
any ‘view’ on the level of the exchange rate. The Reserve Bank is
voting patterns of the MPC in other central banks guided by the objective of containing excess volatility in the foreign
exchange market and not by any specific level of and/or band around
(Table I.1). the exchange rate.
3. Global growth projections are from the World Economic Outlook
Macroeconomic Outlook (January and July 2019 Updates), International Monetary Fund (IMF).
4. BE: Budget estimates.
Chapters II and III analyse the macroeconomic 5. Combined fiscal deficit refers to that of the Centre and States taken
together.
developments during April-September 2019 and Sources: RBI staff estimates; Budget documents; and IMF.
explain deviations of inflation and growth outcomes
vis-à-vis staff’s projections. Turning to the outlook,
Table 1.1: Monetary Policy Committees and the evolution of key macroeconomic and financial
Voting Pattern variables over the past six months warrants revisions
Country Policy Meetings: April 2019 - September 2019 in the baseline assumptions (Table I.2).
Total Meetings with Meetings with
Meetings Full Consensus Dissents First, international crude oil prices declined between
Brazil 4 4 0
mid-May and mid-September reflecting weakness in
Chile 4 3 1 global demand amidst excess supply conditions and
Czech Republic 4 2 2 large stockpiles, despite geo-political tensions and
Hungary 5 5 0
production cuts by the Organisation of the Petroleum
Israel 4 1 3
Japan 4 0 4 Exporting Countries (OPEC) (Chart I.1). Crude oil
South Africa 3 2 1 prices hardened temporarily in the second half of
Sweden 3 3 0
Thailand 4 3 1
September following disruptions to production in
UK 4 4 0 Saudi Arabia. Given the current demand-supply
US 4 1 3 assessment, the baseline scenario assumes crude oil
Sources: Central bank websites. prices at an average of US$ 62.6 per barrel.
10 RBI Bulletin October 2019

Second, the nominal exchange rate (Indian rupee, INR and services, reflecting the slowdown in domestic
vis-à-vis the US dollar) has depreciated from its April demand. Looking ahead, inflation expectations
level, especially during August, impacted by a drop feed into future inflation through price and wage
in the Chinese renminbi below the psychological contracts. One-year ahead inflation expectations
level of 7 yuan per US$ in the wake of an escalation of urban households increased by 20 bps over the
in US-China trade actions. A generalised flight to previous round in the September round of the survey
safety towards the US dollar assets and portfolio conducted by the Reserve Bank; three-month ahead
capital outflows also amplified pressures on the inflation expectations moved up by 40 bps during
rupee. The rupee came under renewed pressure this period (Chart I.3).1 According to the Reserve
in mid-September following the spike in crude oil Bank’s consumer confidence survey for September,
prices but recovered in subsequent days following
the announcement of various measures by the
government to boost investment and growth and to
stabilise the flow of funds into the capital market.
Third, the weakening of global economic activity
and trade is confirmed by the global manufacturing
purchasing managers’ index (PMI) remaining in
contraction zone in September 2019 at 49.7, the
World Trade Organisation's Goods Trade Barometer
indicating weakness in merchandise trade persisting
in Q3:2019 and downgrades to global growth
projections by various agencies. Against this backdrop,
global growth for 2019 and 2020 is now expected to
be below the April baseline (Table I.2 and Chart I.2).
I.2 The Outlook for Inflation
Headline CPI inflation has remained below target
1
The Reserve Bank’s inflation expectations survey of households is
so far in 2019-20. Importantly, inflation excluding conducted in 18 cities and results of the September 2019 survey are based
food and fuel has softened across major goods on responses from 5,810 households.

inflation expectations moderated from the previous projected at 3.4 per cent in Q2:2019-20, 3.5 per cent
round. in Q3, and 3.7 per cent in Q4, with risks evenly
Manufacturing firms polled in the July-September balanced (Chart I.6). The 50 per cent and the 70 per
2019 round of the Reserve Bank’s Industrial Outlook cent confidence intervals for headline inflation in
Survey (IOS) expected an increase in the cost of raw Q4:2019-20 are 2.7-4.7 per cent and 2.2-5.3 per cent,
materials and muted selling prices in Q3:2019-20 respectively. For 2020-21, assuming normal monsoon
(Chart I.4).2 According to the purchasing managers’ and no major exogenous or policy shocks, structural
survey for manufacturing firms, input prices eased model estimates indicate that inflation will move in
in September due to weak demand for raw materials a range of 3.5-4.0 per cent. The 50 per cent and the 70
and semi-finished items; output prices registered
a marginal increase. Services sector firms reported
lower input prices and higher output prices in
August.
Professional forecasters surveyed by the Reserve
Bank in September 2019 expected CPI inflation to
increase from 3.2 per cent in August 2019 to 3.9 per
cent in Q4:2019-20 and to 4.0 per cent in Q2:2020-21
(Chart I.5).3
Taking into account the initial conditions, the signals
from forward-looking surveys and estimates from
time-series and structural models, CPI inflation is
2
The results for the July-September round of the industrial outlook survey
are based on responses from 481 companies.
3
29 panelists participated in the September 2019 round of the Reserve
Bank’s survey of professional forecasters.

per cent confidence intervals for Q4:2020-21 are 2.5- and spatial – could impinge upon the prospects for
5.4 per cent and 1.8-6.2 per cent, respectively. agriculture.
There are both upside and downside risks to Turning to the outlook, consumer confidence for
the baseline inflation forecasts. The upside risks the year ahead moved lower in the May, July and
include: volatility in international and domestic September rounds of the Reserve Bank’s survey, due
financial markets from trade tensions, Brexit and to ebbing of sentiments on the general economic
monetary policy stances of the major AEs; supply situation and the employment scenario (Chart I.7).4
disruptions in the global crude oil market due to geo-
Sentiment in the manufacturing sector polled in the
political tensions; and, sudden spikes in the prices
July-September 2019 round of the Reserve Bank’s IOS
of perishable food items. Downside risks could
dipped for the quarter ahead, reflecting moderation
emanate from more than assumed softening in crude
in expected production, order inflows, capacity
oil and other commodity prices due to sluggish global
utilisation, employment conditions and exports
demand, and weaker inflation excluding food and
(Chart I.8).
fuel domestically due to depressed domestic demand
conditions. Surveys by other agencies of future business
expectations indicate a mixed picture (Table I.3).
I.3 The Outlook for Growth
Firms in the manufacturing and services sectors
As indicated earlier, domestic economic activity polled in the Nikkei’s purchasing managers’ surveys
turned out to be weaker in H1:2019-20 vis-à-vis were optimistic about one-year ahead output
projections in the April 2019 MPR in an environment prospects.
of global headwinds. The expected pick-up in both
In the September 2019 round of the Reserve Bank’s
private consumption and investment failed to
survey, professional forecasters expected real GDP
materialise, and exports lost momentum under the
weight of the slump in world trade. Although the growth to recover from 5.0 per cent in Q1:2019-20 to
south-west monsoon turned out to be above long 4
The survey is conducted by the Reserve Bank in 13 major cities and the
period average, its uneven progress – both temporal September 2019 round is based on responses from 5,192 respondents.

7.2 per cent in Q4:2019-20 and then moderate to 7.0

Table I.4: Projections - Reserve Bank and
per cent in Q2:2020-21 (Chart I.9). Professional Forecasters
(Per cent)
Taking into account the baseline assumptions, survey
2019-20 2020-21
indicators, the reductions in the policy repo rate since
Reserve Bank’s Baseline Projection
February 2019, the base effects and model forecasts,
Inflation, Q4 (y-o-y) 3.7 4.0
real GDP growth is projected at 6.1 per cent in
Real GDP Growth 6.1 7.0
2019-20 – 5.3 per cent in Q2, 6.6 per cent in Q3, 7.2 Median Projections of Professional
per cent in Q4 – with risks evenly balanced (Table I.4). Forecasters
For 2020-21, the structural model estimates indicate Inflation, Q4 (y-o-y) 3.9 4.0#
Real GDP growth 6.2 7.0
real GDP growth at 7.0 per cent – quarterly growth
Gross domestic saving (per cent of GNDI) 30.1 30.5
rates in the range of 6.5-7.4 per cent – assuming a
Gross capital formation (per cent of GDP) 31.0 31.0
Credit growth of scheduled commercial 12.0 12.9
Table I.3: Business Expectations Surveys banks
Item NCAER FICCI Dun and CII Combined gross fiscal deficit (per cent of 6.1 6.0
Business Overall Bradstreet Business GDP)
Confidence Business Composite Confidence Central government gross fiscal deficit (per 3.3 3.3
Index (July Confidence Business Index cent of GDP)
2019) Index (June Optimism (September Repo rate (end-period) 5.0 -
2019) Index (July 2019) Yield on 91-days treasury bills (end-period) 5.2 5.4
2019)
Yield on 10-year central government 6.3 6.5
Current level of 121.8 59.6 70.0 52.5 securities (end-period)
the index Overall balance of payments (US$ billion) 15.1 10.0
Index as per 115.4 60.3 78.4 59.6 Merchandise exports growth 1.5 6.3
previous survey
Merchandise imports growth 0.5 7.1
% change, q-o-q 5.5 -1.2 -10.7 -11.9
Current account balance (per cent of GDP) -1.9 -2.0
% change, y-o-y 6.5 -16.1 -13.2 -19.1
Note: GNDI: Gross National Disposable Income.
Notes: 1. NCAER: National Council of Applied Economic Research. #
: Q2:2020-21.
2. FICCI: Federation of Indian Chambers of Commerce & Industry. Source: RBI staff estimates; and Survey of Professional Forecasters
3. CII: Confederation of Indian Industry. (September 2019).

banks to their lending rates impart an upward bias to

the baseline growth projection path. However, further
escalation of trade tensions, a hard or no-deal Brexit
and increased volatility in global financial markets
pose downside risks to the baseline growth path.
I.4 Balance of Risks
The baseline projections of inflation and growth
in the preceding sections are conditional on the
assumptions relating to the key variables set out
in Table I.2. Uncertainties surrounding these
assumptions could lead to upward and downward
deviations from baseline projections. This section
assesses the balance of risks to the baseline
projections in plausible alternative scenarios.
(i) Global Growth Uncertainties
The baseline scenario assumes a slowdown in
normal monsoon, and no major exogenous or policy external demand in 2019 and 2020. Yield curve
shocks. inversion in major AEs has raised concerns about
the growth outlook (Box I.1). Global growth could
There are upside as well as downside risks to the turn out to be weaker if there is further escalation
baseline growth scenario (Chart I.10). The measures of trade tensions, a hard/no-deal Brexit, a greater-
announced by the government in August-September than-envisaged slowdown in some major economies
to boost growth and investment – policy reforms like China, or a combination of these factors. In
on foreign direct investment (FDI), upfront release such a scenario, if global growth slips down by 50
of funds for recapitalisation of public sector banks bps vis-à-vis the baseline, domestic growth and
(PSBs), merger of PSBs, incentives for exports and real inflation could be lower by around 20 bps and 10
estate, reduction in the corporate income tax rate – bps, respectively, from their baseline trajectories
along with a faster resolution of stressed assets, and (Charts I.11a and I.12a). Conversely, an expeditious
a faster pace of transmission of past repo rate cuts by and orderly resolution of trade tensions, and/or a

Box I.1: Does Yield Spread Predict Output Growth?

The spread between yields on the US 10-year and According to the expectations hypothesis of the term
3-month treasury securities – a closely watched structure, long-term interest rates equal the sum of
metric for term spread – has inverted for the first current and expected future short-term interest rates
time since 2007 and turned negative at 13 basis plus a term premium. The term premium explains
points (bps) in June 2019. The spread has remained why the yield curve usually slopes upwards, i.e.,
in negative territory for the third consecutive month yields on long-term securities usually exceed those
in August at 35 bps (from 83 bps a year ago). on short-term securities. The yield curve flattens or
Since the 1950s, US recessions have been preceded inverts/slopes downward when the public expects
by sizeable inversions in the yield curve. The only short-term interest rates to fall. In such a scenario,
occasion when the 3-month Treasury security investors bid up the prices of longer-term securities
yield exceeded the 10-year Treasury yield without causing a fall in long-term yields relative to yield
the occurrence of a subsequent recession was in on short-term securities. There is no unanimity,
September 1966. Barring this, yield curve inversion however, on the theoretical relationship between
has coincided with a recession in the following 18-24 the term spread and economic activity. To a large
months (Chart I.1.1a). extent, the usefulness of the spread for forecasting
Inversion/narrowing of yield spreads has occurred economic activity remains a “stylised fact in search
in other AEs. Yields have flattened in Germany, of a theory” (Benati and Goodhart, 2008). Moreover,
the UK, Japan, Singapore and Australia, mirroring the predictive power of the term spread for output
a slowdown in the global economy. In the case of growth depends on monetary policy objectives and
Germany, the spread of the 10-year bond yield over the reaction function used. In the case of monetary
the 3-month bond yield turned negative falling to 24 policy tightening for example, short-term rates are
bps in August 2019 as compared with 61 bps a year likely to rise more than long-term rates and cause
ago. Germany experienced recessions beginning in the yield curve to flatten or possibly invert (Feroli,
1966, 1973, 1980, 1991, 2001 and 2008. All recessions, 2004). It is also argued that the term spread forecasts
except the 1966 recession, were preceded by a sharp output growth better, the more responsive the
decline in long-term Treasury security yields relative monetary authority is to deviations of output from
to short-term yields. The only inversion that was not potential. The spread forecasts less accurately if
followed by a recession was in 1970 (Chart I.1.1b). monetary policy focusses exclusively on controlling

Table I.1.1: Correlation between GDP Growth and Yield Spreads

Lagged Yield Spread Future Yield Spread
Country t-6 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 t+6
US 0.136 0.192 0.218 0.213 0.229 0.154 0.041 -0.073 -0.166 -0.204 -0.231 -0.341 -0.360
(0.042) (0.004) (0.001) (0.001) (0.001) (0.021) (0.545) (0.278) (0.013) (0.002) (0.001) (0.000) (0.000)
Germany 0.268 0.272 0.307 0.291 0.322 0.119 -0.026 -0.207 -0.372 -0.385 -0.400 -0.418 -0.311
(0.037) (0.034) (0.016) (0.023) (0.011) (0.361) (0.843) (0.110) (0.003) (0.002) (0.001) (0.001) (0.015)
Notes: 1. Yield spread between 10-year and 3-month Treasury securities has been measured as the quarterly average of monthly observations.
2. Data for the US and Germany pertain to the period Q2:1962–Q2:2019 and Q4:2002–Q2:2019, respectively.
3. Figures in the parentheses represent p-values.
Sources: Bloomberg; and RBI staff estimates.
inflation. The consumption smoothing model steeper is the yield curve – higher the yield on 10-
derives a relationship between the slope of the yield year Treasury securities relative to that on 3-month
curve and future economic activity by assuming that Treasury securities – the higher is the future rate of
individuals prefer stable consumption rather than GDP growth. Similarly, correlations between GDP
high consumption during periods of rising income growth and future yield spreads up to six quarters
and low consumption when income is falling (Harvey, have been found to be negative and statistically
1988). If they expect a recession in the future, significant for both countries, except for period t+1
consumers sell short-term financial instruments and where it is insignificant for both countries. Negative
purchase bonds at a discount to generate income, correlations between GDP growth and the lead terms
resulting in a flattening or inversion of the yield of the yield spread suggest that higher the GDP
curve. growth in period t, less steep would be the yield
curve in subsequent quarters (Sahoo and Gupta,
The empirical literature suggests that the yield
2019).
spread predicts output growth at a four-to-six-quarter
horizon with considerable variation across countries To sum up, the yield spread has been useful in
and over time. However, the ability of the term predicting output growth and recessions at least up
spread to forecast output growth has declined since to one year in advance, particularly in major AEs,
the mid-1980s (Wheelock and Wohar, 2009). On the although its signalling value has somewhat blurred
other hand, probit models show that the yield spread in the present environment of unconventional
monetary policies. The current phase of negative
outperforms in relation to other macroeconomic and
yield spreads warrants that policymakers remain
financial variables while predicting the probability
vigilant.
of recession (Estrella and Hardouvelis, 1991; Estrella
and Mishkin, 1998). References:
The contemporaneous correlation between the Benati, L. and C. Goodhart (2008), “Investigating
yield spread and real GDP growth was found to Time-Variation in the Marginal Predictive Power of
be statistically insignificant for both the US and the Yield Spread”, Journal of Economic Dynamics
Germany (Table I.1.1). However, correlations and Control, 32(4), pp. 1236-72.
between GDP growth and the yield spread lagged by Estrella, A. and G. A. Hardouvelis (1991), “The Term
one to six quarters were found to be positive and Structure as a Predictor of Real Economic Activity”,
statistically significant for both the countries, except Journal of Finance, 46(2), pp. 555-76.
for the period t-1 for Germany, where it was found to Estrella, A. and F. S. Mishkin (1998), “Predicting
be insignificant. These correlations suggest that the U.S. Recessions: Financial Variables as Leading

Indicators”, Review of Economics and Statistics, Sahoo, S. and B. Gupta (2019), "Does Yield Spread
80(1), pp. 45-61. Predict Output Growth?", Reserve Bank of India
Feroli, M. (2004), “Monetary Policy and the (Mimeo).
Information Content of the Yield Spread”, Topics in Wheelock, D. C. and M. E. Wohar (2009), “Can the
Macroeconomics, 4(1), Article 13. Term Spread Predict Output Growth and Recessions?
Harvey, C. R. (1988), “The Real Term Structure A Survey of the Literature”, Federal Reserve Bank of
and Consumption Growth”, Journal of Financial St. Louis Review, September/October.
Economics, 22(2), pp. 305-33.
smooth Brexit could boost confidence and provide (iii) Exchange Rate
support to global trade and demand. Should
The INR depreciated vis-à-vis the US dollar in August
global growth surprise by 50 bps on the upside,
2019, reflecting global developments. Looking ahead,
domestic growth and inflation could edge higher by
rising trade protectionism, and slowing global
around 20 bps and 10 bps, respectively.
trade and global output could increase volatility in
(ii) International Crude Oil Prices international financial markets and exert further
The Indian basket of crude oil prices has exhibited downward pressure on the currency. Should the INR
high volatility in the first half of 2019-20 and the depreciate by 5 per cent from the baseline, inflation
outlook remains uncertain. Upside risks to the could edge up by around 20 bps and boost net exports
baseline assumption can emanate from geo-political and GDP growth by around 15 bps. In contrast, a
tensions. Assuming crude oil prices increase to US$ slew of measures taken by the government to boost
73 per barrel, inflation could be higher by around 30 output and investment, policy reforms in the FDI
bps and growth weaker by around 20 bps from the regime, and greater than expected monetary policy
baseline. Conversely, crude oil prices could soften accommodation by the central banks in major AEs
further if global demand turns out to be weaker than could attract increased capital inflows and lead to an
expected. Should the price of the Indian basket of appreciation of the INR. An appreciation of the INR
crude fall to US$ 53, inflation could ease by around by 5 per cent could moderate inflation by around 20
30 bps and growth could be higher by around 20 bps bps and GDP growth by around 15 bps vis-à-vis the
(Charts I.11a and I.12a). baseline (Charts I.11b and I.12b).

(iv) Food Prices 2019-20 and the early months of 2020-21. Volatility

Food prices picked up during April-August, mainly in international and domestic financial markets, as
due to pressures from prices of vegetables and pulses. well as global crude oil prices, and domestic prices
However, overall food inflation remains benign. The of perishable food items pose upside risks to the
baseline path assumes that food inflation will firm baseline inflation path. On the other hand, the
up in the near term reflecting, inter alia, the seasonal softer outlook on global commodity prices and large
pick-up in prices of vegetables and some pick-up buffer stocks could keep headline inflation below the
in prices of pulses as the demand-supply balance baseline.
stabilises. There are both upside and downside risks Real GDP growth is expected to recover in H2:2019-
to the baseline. The strong revival of monsoon during 20, facilitated by favourable base effects and
July-September and the resultant catch-up in kharif transmission of past monetary policy actions.
sowing, large buffer stocks, and improved prospects
The measures announced by the government in
for rabi crops from better reservoir levels could soften
August-September to boost growth – such as release
food inflation more than assumed, and consequently,
of funds for recapitalisation of public sector banks,
headline inflation could be below the baseline by up
merger of public sector banks, reforms in the FDI
to 50 bps. However, heavy rains and floods in some
regime, initiatives for exports and the real estate
areas could exert some upward pressure on food
sector, reduction in the corporate income tax rate –
inflation and accordingly, headline inflation could be
and faster resolution of stressed assets could push
higher by around 50 bps (Charts I.11b and I.12b).
growth above the baseline path. Intensification of
I.5 Conclusion global uncertainty around US-China trade tensions,
Headline inflation is projected to remain below the a hard Brexit and geo-political tensions are key
medium-term target of 4 per cent over the rest of downside risks to the baseline growth path.

II. Prices and Costs ebbed by around 100 basis points between March-
June 2019 and reached a 23-month low in June 2019,
Consumer price inflation registered an uptick during before registering some uptick during July-August
March-August 2019, underpinned by a pick-up in food (Chart II.1).
inflation, particularly in vegetables and protein-based The RBI Act, 1934 (amended in 2016) enjoins the
items. Fuel group inflation moderated sequentially after RBI to set out deviations of actual outcomes from
April and moved into deflation in July and August 2019. projections, if any, and to explain the underlying
Inflation excluding food and fuel has softened since reasons thereof. The Monetary Policy Report (MPR)
March in a broad-based manner notwithstanding a of April 2019 had projected CPI inflation at 2.9 per
sharp increase in gold prices. Nominal growth in rural cent for Q1:2019-20 and 3.0 per cent for Q2:2019-20.
wages, both for agricultural and non-agricultural Actual inflation outcomes have, by and large, tracked
labourers, remained subdued. Growth in organised sector these projections (Chart II.2).
staff costs showed divergent movements – rising for the
While food prices moved out of deflation as anticipated,
manufacturing sector and remaining range bound for
the summer rise in prices of vegetables this year was
the services sector. Farm inputs and industrial raw
more pronounced than observed in recent history.
materials price inflation has softened in 2019-20 so far.
Pulses prices moved out of two and a half years of
Over the last six months i.e., March-August 2019 deflation in May 2019. As a result, food inflation
consumer price index (CPI) inflation trailed below the inched up by 230 basis points, larger than expected,
target of 4.0 per cent averaging 3.1 per cent over this between March and August 2019. Meanwhile,
period.1 Its key driver was food prices which emerged inflation excluding food and fuel softened more than
out of deflation in March 2019 and gradually firmed anticipated, providing an offset. The Indian basket of
over the ensuing months in the usual summer season crude oil prices eased unexpectedly – from an average
upturn. In contrast, prices of fuel and light items of US$ 67 per barrel during 2019-20 (which was the
remained soft and slumped into deflation during baseline assumption in the April MPR) to below US$
July-August 2019. Excluding food and fuel, inflation 60 per barrel in August. Prices within the fuel group
1
Headline inflation is measured by year-on-year changes in all India CPI Combined (Rural and Urban).

underwent substantial correction in respect of both

rural items of consumption such as firewood and
dung cake and those of urban usage such as liquefied
petroleum gas (LPG). Consequently, the fuel group as
a whole slipped into deflation during July-August. On
the whole, these divergent movements caused CPI
headline inflation outcomes to marginally overshoot
inflation projections, i.e., by 20 basis points each in
Q1:2019-20 and Q2:2019-20 (July-August) (Chart II.2).
II.1 Consumer Prices
A decomposition of year-on-year (y-o-y) inflation
shows that its rising trajectory during March to June
2019 was propelled by a sustained increase in price
momentum (Chart II.3). In July, large favourable base
effect helped moderate the high price momentum.2
In August, however, the price momentum outweighed
a low base effect and consequently, inflation edged
2
Inflation (i.e., the y-o-y change in CPI) in any given month arithmetically equals the previous month’s inflation plus the difference between current
month-on-month (m-o-m) change in the price index (momentum) and the m-o-m change in the price index 12 months earlier (base effect). See Box 1.1 of
MPR, September 2014.

up marginally. The elevation in price momentum in adjusted basis moderated during June-August 2019
H1:2019-20 was driven by the food group, mainly across both goods and services categories (Chart II.5).3
by prices of vegetables, pulses, meat and fish. In
II.2 Drivers of Inflation
contrast, the momentum underlying fuel and light
A historical decomposition of inflation shows that it
inflation collapsed during July-August under the
weight of a broad-based decline in prices of items of was impacted by positive supply shocks in H1:2019-
rural and urban fuel consumption. The momentum 20, which, in conjunction with subdued domestic
of prices of items excluding food and fuel moderated demand, kept headline inflation low and stable (Chart
during March-August 2019 and was completely II.6a).4
overwhelmed by favourable base effects, barring July. The break-up of overall CPI inflation into goods
The distribution of inflation across CPI groups and services components suggests that perishable
shows a considerable drop in median inflation rates goods (non-durable goods with 7-day recall) such as
– from 4.8 per cent in 2018 to 2.1 per cent in 2019 vegetables and fruits were the largest contributor to
so far. Moreover, the negative skew in inflation overall inflation during April-August (Chart II.6b). The
in 2017 and 2018 resulting from food prices was contribution of less perishable goods (non-durable
absent in 2019, implying that a generalised goods with 30-day recall) moderated due to deflation in
moderation in inflation was underway this year prices of rice, petroleum products, LPG and electricity.
(Chart II.4). Diffusion indices of month-on-month The contribution of durable goods to overall inflation
(m-o-m) price changes in CPI items on a seasonally increased during June-August 2019, primarily on
3
The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their prices have risen,
remained stagnant or fallen over the previous month. A reading above 50 for the diffusion index signals generalisation of price increases and a reading
below 50 signals a broad-based deflation.
4
Historical decompositions are used to estimate the contribution of each shock to the movements in inflation over the sample period, based on a Vector
Auto Regression (VAR) with the following variables (represented as the vector Yt) – the annual growth rate in crude oil prices; inflation; the output gap; the
annual growth rate in rural wages and the policy repo rate. The VAR can be written in reduced form as: Yt =c + A Yt-1 + et ; where et represents a vector of
shocks [oil price shock; supply shock (inflation shock); output gap shock; wage shock; and policy shock]. Using Wold decomposition, Yt can be represented
as a function of its deterministic trend and sum of all the shocks et. This formulation facilitates decomposition of the deviation of inflation from its
deterministic trend into the sum of contributions from various shocks.

account of a sharp increase in prices of gold and to for the same period a year ago. Inflation in the food
a lesser extent, in those of motor vehicles. Imported group turned positive beginning March 2019 – after
goods (petrol; diesel; LPG; kerosene; electronic goods; remaining in the negative zone for five consecutive
gold; silver; chemical and chemical products; metal months during October 2018-February 2019 – and
and metal products; and refined vegetables oils) increased steadily thereafter driven by prices of
together contributed negatively to overall inflation vegetables, fruits and protein-rich items such as
in the recent period (Chart II.6c). The contribution pulses, meat, fish and milk (Chart II.7a).
of services to overall inflation moderated. However,
Within the food and beverages group, the price
services (with a weight of 23.4 per cent in overall
build-up during the financial year so far in the case
CPI) contributed to about a third to overall inflation
of vegetables has been substantial, but close to
(Chart II.6b).
historical summer price increases. In the case of fruits,
CPI Food Group pulses, meat and fish, the price build-up has been,
In terms of weighted contribution, the food and in fact, larger than the historical average (2011-18).
beverages group (weight: 45.9 per cent in CPI) For all the other sub-groups within the food group,
contributed 32.9 per cent to overall inflation during the build-up has been much lower than in the past
April-August 2019 as compared with 25.0 per cent (Chart II.7b).

Inflation in respect of cereals (weight of 9.7 per cent months and thunderstorms in several parts of northern
in CPI and 21.1 per cent in the food and beverages and north-eastern states that spoiled the produce in
group) remained moderate during April-August 2019, transit. Despite this firming up, potato prices moved
with rice prices remaining in deflation, reflecting into deflation beginning April 2019 on account of
robust production and adequate stocks. As per the favourable base effects. Onion prices, which had
fourth advance estimates of foodgrain production, declined during December 2018-March 2019, revived
production of rice was at 1164 lakh tonnes in 2018- from April with a sharp uptick during June-August.
19, higher than 1128 lakh tonnes in 2017-18, which A reduction in rabi onion acreage in Maharashtra,
was until recently an all-time record. Exports of particularly in the major onion-producing district of
rice declined during April-July 2019 as the 5 per Nashik due to drought-like conditions, led to a slump
cent incentive provided by the government to rice in mandi arrivals. Onion prices were also supported by
exporters under the Merchandise Exports from India procurement operations by the National Agricultural
Scheme (MEIS) was withdrawn from April 1, 2019 and Cooperative Marketing Federation of India (NAFED)
this resulted in higher domestic availability. Wheat in Maharashtra. Excessive rainfall, coupled with
inflation, however, remained high at an average of
floods in several parts of major onion-supplying states
6.8 per cent during April-August 2019 (3.4 per cent in
such as Maharashtra, Karnataka and Madhya Pradesh
2018-19) due to a fall in imports following a hike in
during July-August, also led to a reduction in supplies.
import duty to 40.0 per cent in April 2019 from 30.0
Tomato prices began picking up from March 2019,
per cent in May 2018.
with inflation in this item rising sharply to 70.1 per
As regards vegetables (weight of 6.0 per cent in CPI cent in May 2019 from (-) 52.2 per cent in November
and 13.2 per cent in the food and beverages group), 2018. Delayed harvesting in Maharashtra as well as
a recovery in the prices of onions, tomatoes and fungus damaged crops in Karnataka triggered the
potatoes (which account for 36.5 per cent of the total initial uptick in prices, which was exacerbated by
CPI vegetables) led the upturn in prices (Chart II.8a). supply disruptions due to incessant rains and flood-
Potato price pressures picked up right from April 2019. like situations in key supplier states – Karnataka,
First, untimely rains during February and March in Maharashtra and Himachal Pradesh. Tomato inflation,
West Bengal impacted the crop which was ready to however, eased to 28.4 per cent in July largely due to
be harvested. Second, mandi arrivals declined due a favourable base effect, before hardening to 39.4 per
to a sudden increase in temperature during summer cent in August on account of an adverse base effect.

A decomposition of CPI vegetables into trend, cyclical statistically significant higher volatility in m-o-m
and seasonal components reveals that the cyclical changes in prices of vegetables and fruits in urban
upswing, starting from December 2018, was the key areas than in rural areas5.
driver of the vegetables inflation during H1:2019-20
CPI pulses (weight of 2.4 per cent in CPI and 5.2 per
(till July 2019), with the trend component remaining
cent in the food and beverages group), driven by a
flat. The seasonal uptick during the summer season
sustained uptick in prices, emerged from 29 successive
tracked the pattern in previous years (Chart II.8b).
months of deflation in May 2019 to reach a 35-month
Prices of fruits (weight of 2.9 per cent in CPI and 6.3 high inflation of 6.9 per cent in August 2019 (Chart
per cent within the food and beverages group) moved
II.9a). Even so, the CPI pulses index remained below
into deflation in December 2018. Fruits prices began
trend (Chart II.9b). Pulses production was lower at 234
rising from February 2019 with sharp uptick in April
lakh tonnes (as per the fourth advance estimates) in
and July. However, fruits remained in deflation up to
2018-19 than 254 lakh tonnes in 2017-18. In addition,
August 2019. Price pressures were particularly evident
pulses imports declined from 57 lakh tonnes in 2017-
in respect of bananas and apples, which together
18 to 26 lakh tonnes in 2018-19, reducing the domestic
constitute around 35.6 per cent of the category of
fruits. While banana prices were impacted by lower supply glut. A sizeable stock of pulses – at around 40
mandi arrivals, apple prices increased in the usual lakh tonnes – is available, which could be released in
seasonal upturn. Apple prices were also supported by the market to contain price pressures.
lower imports following the increase in import duty Meat and fish prices also contributed to the pick-up
on apples from the US by 20.0 per cent in June 2019. in food inflation, partly reflecting the sustained rise
However, price pressures in respect of both bananas in feed prices, particularly of maize. In fact, inflation
and apples declined in August due to higher domestic in meat and fish prices was the highest in 62 months
arrivals in mandis. in July 2019. While egg prices moved in line with
The rise in prices of vegetables and fruits during the their historical pattern, those of milk and products
summer months of 2019 was witnessed in urban as hardened during May-August 2019, primarily
well as rural areas. A sectoral analysis suggests that reflecting an increase in retail milk prices by ₹2 per
there is no statistically significant difference between litre to ₹6 per litre due to pass-through of an increase
the m-o-m changes in prices of fruits and vegetables in procurement prices of milk by ₹5-6 per litre by milk
between rural and urban areas. There is, however, co-operatives.
5
Based on a F-test and t-test framework. The robustness of the results was tested using both seasonally adjusted and unadjusted data.

Prices of sugar emerged out of deflation in May 2019 Inflation in respect of oils and fats remained subdued
after remaining in negative territory for 15 consecutive at around 0.8 per cent during April-August 2019,
months. However, they slipped back into deflation with soft international prices and higher domestic
during June-August 2019, reflecting domestic supply production keeping prices under check. According
surpluses as well as favourable base effects. As per the to the fourth advance estimates, oilseeds production
Indian Sugar Mills Association (ISMA), the opening increased by 2.5 per cent in 2018-19; however, a
stock of sugar as on October 1, 2019 is expected to be decline in groundnut production during the year
at an all-time high of 145 lakh tonnes. International contributed to price pressures in groundnut oil during
a major part of 2018-19 as well as in 2019-20 so far.
sugar prices, which were in deflation during May
2017-February 2019 due to persistent excess global CPI Fuel Group
supply, also returned to positive territory in March Fuel group inflation moderated sequentially after
2019. Some increase in sugar prices in the domestic April up to June and sank into deflation in July and
market was observed in Q1:2019-20, possibly August 2019, with inflation in major constituents
reflecting the increase in minimum selling prices of such as electricity, LPG, firewood and chips and dung
sugar by ₹2 per kilogram in February 2019. cake all slipping into negative territory (Chart II.10a).

After registering price increases between March-

June, domestic LPG prices declined abruptly in July
and August, following a collapse in international
petroleum products prices (Chart II.10b). Electricity
prices, which constitute around one-third of the fuel
and light sub-group, have been in deflation for most
of the months since January 2019. Prices of items of
rural consumption such as firewood and chips, and
dung cake have also remained in deflation since April
2019. This could partly be on account of increased LPG
use in rural areas.6 In contrast, administered kerosene
prices registered calibrated increases as oil marketing
companies (OMCs) raised administered prices to
align them more closely with market prices so as
to eventually phase out the subsidy on petroleum
products.
2019, it was not sustained and it moderated by about
CPI excluding Food and Fuel 30 bps in August (Chart II.11).
CPI inflation excluding food and fuel moderated Within CPI excluding food and fuel, price increases
by close to 100 bps between March and June 2019. during the financial year so far have been considerably
Even excluding volatile components such as lower than historical averages for most of the
petroleum products, gold and silver, it moderated constituent sub-groups (Chart II.12).
by around 70 bps, reflecting the broad-based nature Empirical evidence suggests that persistently low
of the disinflation in this group. Although inflation food inflation has spilled over to CPI excluding food
excluding food and fuel picked up by 35 bps in July and fuel (Box II.1).
6
Rural households were provided LPG connections under the Pradhan Mantri Ujjwala Yojana (PMUY), which significantly improved the LPG coverage (all
India) from 62 per cent in 2015-16 to 94 per cent in 2018-19. Estimates suggest that this could have contributed to around 1.60 percentage points reduction
in inflation in traditional sources of cooking fuels like firewood and chips and dung cakes.

Box: II.1: Time-varying Estimates of Spillovers from Food Inflation to Inflation

excluding Food and Fuel
Movements in food inflation have direct and indirect Let Yt denote a n ×1 vector i, z of 5
effects on headline inflation – directly through variables at time t. Then,
the relative weight of food in the CPI basket, and
indirectly by second round effects through changes Yt = Xt βt + At-1Σt εt, t = s+1….n. (1)
in inflation expectations, wages and relative price Where Xt = Is⊗(Yt-1’… Yt-s’); at = (a21, a31, a32, a41, .
adjustments (Cecchetti and Moessner, 2008). . . , a54) is a stacked vector of the lower-triangular
Empirical results based on cross-country evidence elements in At; ht = (h1t, . . . , hkt) with hjt = logσ2jt
suggest that volatile and persistent food price shocks for j = 1, . . . , k, t = s+1, . . . , n and βt be the vector
in economies having a large share of expenditure on of coefficients. It is assumed that parameters in (1)
food in the consumption basket are likely to have follow a random walk process as in (2).
larger and longer effects of food inflation on non-
food inflation (Walsh, 2011). These spillovers could βt +1 =βt + u βt  εt   I 0 0 0 
  
be time dependent and conditioned by the state a t +=
u 
a t + u at with  ât  ~ N  0, 0 Σβ 0 0   (2)
1
of the economy. A time-varying parameter vector h = h + u  u at   0 0 Σa 0 
    
Σ h  
t +1
autoregression with stochastic volatility (TVP-VAR),
t ht
 u ht   0 0 0
(Primiceri, 2005), was employed to estimate the time- for t = s+1, ... , n.
varying pass-through coefficients. It is based on five
variables, viz., the output gap (deviation of output The empirical results suggest that (i) pass-through
from its potential level, y ); food inflation ; coefficients are time varying – ranging between 8 per
inflation excluding food and fuel ; the policy cent and 14 per cent during Q3:2003-04 to Q1:2019-
interest rate (i ) (proxied by the call money rate, 20; (ii) pass-through is high when food inflation is
which is the operating target of monetary policy), and high and persistent, and low when food inflation is
the exchange rate (Indian Rupees per US$) changes low. In the recent low food inflation scenario, the
(z ), over the sample period from Q1:1996-97 pass-through coefficient has moderated to around 10
to Q1:2019-20.7 The estimated model can be per cent (Chart II.1.1a & b). In view of this asymmetric
represented as follows: impact of food inflation on inflation excluding food
(Contd.)
7
CPI food price and CPI excluding food and fuel price indices, prior to 2011 were estimated using the corresponding indices of CPI Industrial Workers.

and fuel, maintaining low and stable food prices Settlements Quarterly Review, Bank for International
becomes critical to contain underlying inflation Settlements, pp. 55–66.
pressures. This would entail supply side reforms to Reserve Bank of India (2014), ‘Report of the Expert
ensure that food inflation remains under check. Committee to Revise and Strengthen the Monetary
Policy Framework (Chairman: Dr Urjit R. Patel)’.
Reference
Primiceri, G. (2005), ‘Time Varying Structural Vector
Bordoloi, S. (2019), “Spill-over from Food inflation Autoregressions and Monetary Policy’, Review of
to Core inflation in India: An Empirical Analysis”, Economic Studies, 72, pp. 821-852.
(Mimeo).
Walsh, J. (2011), ‘Reconsidering the role of food
Cecchetti, S. and Moessner, R. (2008), ‘Commodity prices in inflation’, IMF Working Paper, WP/11/71,
prices and inflation dynamics’, Bank for International International Monetary Fund.
Inflation in the transport and communication sub- clothing and footwear, mainly in rural areas. Other
group moderated primarily due to a sustained deflation sub-groups contributing to the goods moderation
in petroleum product prices (Chart II.13a). However, were personal care items, particularly, gold; silver; and
the wedge between international and domestic prices toiletries, and household goods and services items.
remains considerable due to an incomplete pass- The pick-up in goods inflation since June has almost
through (Chart II.13b). entirely emanated from the personal care and effects
sub-group, driven by a sharp pick-up in gold prices.
An examination of the components of CPI excluding Services inflation moderated from elevated levels in
food, fuel, petrol and diesel inflation in terms of February 2019 to 4.9 per cent in August 2019 (Chart
goods and services shows that while goods inflation II.14b) in a broad-based manner across education
saw phases of both moderation (February-May) and services like tuition and coaching; transportation
uptick (June-August), services inflation has fallen fares, particularly, bus fares; medical services;
persistently (Chart II.14a & b). A key sub-group housing; and household services like sweeping and
contributing to the downturn in goods inflation was tailoring charges.

Other Measures of Inflation Inflation in wholesale price index (WPI) fell steadily
in contrast to the sectoral CPIs to a low of 1.1 per cent
Inflation in sectoral CPIs, i.e., for industrial workers
in August 2019. On the one hand, fuel group inflation
(CPI-IW), agricultural labourers (CPI-AL) and rural
collapsed from 4.6 per cent in March to (-) 4.0 per cent in
labourers (CPI-RL), rose rapidly between March
August 2019 tracking international petroleum product
and June 2019 compared with the muted uptick in
prices; inflation in non-food manufactured products
CPI headline inflation. Inflation in food and fuel
also fell across the board and was in contraction in
components of CPI-AL and CPI-RL was higher than
August. On the other hand, WPI food inflation showed
that in headline CPI and was accentuated by the
an uptick from January and remained elevated till
larger share of food in these indices. In the case of
August, barring a fleeting correction in July. GDP and
CPI-IW, a major source of divergence was the housing
GVA deflators broadly remained in alignment with CPI
component. Following the increase in HRA under the
inflation during the last six months (Chart II.15a).
7th central pay commission (CPC), housing inflation in
CPI-IW remained above 26 per cent during July 2018 Underlying inflation dynamics can be gauged from
to June 2019, pushing CPI-IW inflation to 8.7 per cent exclusion-based measures that remove volatile
by May 2019. As the effect of increase in HRA waned, items/item groups or by statistical measures such
CPI-IW inflation declined to 6.3 per cent in August. as trimming, which adjust for positive and negative

skewness and chronic fat tails in the inflation predominantly reflecting the easing in prices of raw
distribution by removing outliers. By these measures, jute and raw cotton.
inflation have moved with a softening bias over the Of farm sector inputs, price pressures in respect
last six months (Chart II.11 & 15b). of fertilisers remained subdued, largely reflecting
II.3 Costs moderation in international prices, especially those
Developments in underlying cost conditions have of phosphate, di-ammonium phosphate and triple
superphosphate. Inflation in respect of pesticides
largely been in sync with inflation in terms of the
and other agrochemical products also softened
WPI (Chart II.16). Price inflation in farm inputs and
considerably in Q1:2019-20 due to easing of
industrial raw materials (extracted from the WPI) has
international crude oil prices. The price of electricity,
fallen in 2019-20 so far. The moderation in global
which carries a high weight in both industrial and
crude oil prices during 2019-20 has kept domestic
farm inputs, moved into deflation during June-August
price pressures under check in respect of inputs such
2019. However, inflation in fodder prices turned
as high-speed diesel, aviation turbine fuel, naphtha,
positive in January 2019, after remaining in deflation
furnace oil and petroleum coke. In addition, the during August 2016-December 2018 (barring August
contraction in mineral prices has also aided the fall in 2017), to touch a 37-month high of 16 per cent in July
industrial input costs. 2019, before easing somewhat in August. Inflation
Among other industrial raw materials, domestic in terms of agricultural machinery and implements
coal inflation has subsided significantly since the costs has also remained elevated and sticky from
beginning of 2019-20, averaging around 0.7 per cent H2:2018-19.
during April-August 2019. Domestic coal prices largely Growth in nominal rural wages, both for agricultural
moved in line with international coal prices during and non-agricultural labourers, remained subdued and
the period. Inflation in paper and paper products sticky, hovering around 3.7 per cent and 3.8 per cent,
has also moderated due to lower raw material costs respectively, during 2019-20 so far, reflecting the lagged
including those of pulp and coal. In the case of impact of moderate rural inflation, low food prices and
fibres, inflation eased during June-August 2019, a slowdown in the construction sector (Chart II.17).

With inflation in CPI-AL and CPI-RL having picked up costs and selling prices sequentially from Q2:2018-19
since February 2019, however, real rural wage growth, to Q1:2019-20. However, the rate of decline in selling
based on these price indices, turned negative since prices in Q1:2019-20 was sharper than that of input
March 2019. costs. During Q2:2019-20, both input costs and selling
prices firmed up. Input cost inflation reported by firms
Growth in organised sector staff costs showed
in the services sector PMI also softened gradually
divergent movements for services and manufacturing
from Q2:2018-19 to Q1:2019-20 but increased during
firms. Unit labour costs for companies in the
the first two months of Q2:2019-20.
manufacturing sector fell marginally in Q4:2018-19
but rose thereafter in Q1:2019-20 to 6.3 per cent due II.4 Conclusion
to a decline in the value of production, coupled with
The inflation trajectory in 2019-20 so far has been
increase in staff cost.8 Unit labour cost for firms in
characterised by rising food inflation, with price
the services sector increased marginally in the last
build-ups close to historical averages and well above
quarter as higher growth in staff costs outpaced the
levels observed in recent years, driven largely by a
growth in value of production (Chart II.18).
strong summer pick-up in prices of vegetables. Going
Manufacturing firms participating in the Reserve forward, however, the build-up in vegetables prices
Bank’s industrial outlook survey reported a fall in is likely to reverse with arrivals of the kharif harvest
input costs in Q2:2019-20 on account of lower raw and winter supplies. The catch-up in monsoon and
material costs. The cost of finance and salary outgoes sowing should help mitigate price pressures in cereals.
are also expected to soften in Q2. The fall in input Moreover, buffer stocks of cereals are well above
prices is likely to translate into a fall in selling prices prescribed norms. In the case of pulses, the arrival of
in Q2. fresh produce in the market along with buffer stocks
Firms polled for the manufacturing purchasing are also likely to keep prices under check. Going
managers’ index (PMI) reported a decline in input forward, domestic fuel and petroleum product prices
are subject to considerable uncertainty due to geo-
political developments in the Middle East. A sudden
spike in crude oil and petroleum products prices
remains a major upside risk in spite of weak global
demand. However, given the weak domestic demand
and lower input costs, inflation in CPI excluding food
and fuel is likely to remain moderate.
Forward looking surveys of the Reserve Bank
point to weak consumer confidence and sagging
demand, especially pertaining to non-essential items.
Manufacturing firms see input prices as still soft and
pricing power is yet to firm up as the cost of finance
and salary outgoes remain muted. However, inflation
expectations of households have risen somewhat.
On the whole, headline CPI inflation is expected to
remain within the Reserve Bank’s target of 4.0 per
cent during 2019-20.
8
Unit labour cost is defined as the ratio of staff cost to value of production.

III. Demand and Output deepened to 5.0 per cent in Q1:2019-20, extending
the sequential slowdown that set in during Q1:2018-
Aggregate demand weakened in Q1, underpinned by 19 to the fifth consecutive quarter (Table III.1 and
a slowdown in private consumption. On the supply side, Chart III.1a). Momentum, measured by quarter-on-
a sharp deceleration in manufacturing essentially quarter (q-o-q) seasonally adjusted annualised GDP
reflected weaknesses in the organised sector. Services growth rate (SAAR), also moderated to 4.4 per cent
sector growth was pulled down by ‘financial, real estate in Q1:2019-20 from 5.6 per cent in Q4:2018-19
and professional services’ and construction activity. (Chart III.1b).
The recent measures by the Government should help Of the constituents of GDP, private final consumption
kickstart the capex cycle and lead to the strengthening expenditure (PFCE), the mainstay of aggregate
of domestic demand. demand, slumped, with its growth plummeting by
over four percentage points in Q1:2019-20 to an
Domestic economic activity suffered a sharp loss of
eighteen-quarter low. Government final consumption
pace in Q1:2019-20. Aggregate demand weakened in
expenditure (GFCE) cushioned the deceleration in
Q1:2019-20 by a slowdown in private consumption.
aggregate demand. Excluding GFCE, real GDP growth
On the supply side, manufacturing activity collapsed
would have slid down to 4.5 per cent in Q1:2019-
with the prolonged slowdown in the production
20. Gross fixed capital formation (GFCF) remained
of capital goods and consumer durables and in the
weak in Q1:2019-20, with the capex cycle yet to gain
services sector, construction activity slowed down
traction. Export growth decelerated considerably
markedly. Incoming data suggest that the slowdown
in Q1:2019-20 in an uncertain external trading
persisted into Q2:2019-20.
environment rendered hostile by trade tensions.
III.1 Aggregate Demand With import growth reflecting domestic demand
Measured by year-on-year (y-o-y) changes in real conditions and slowing more sharply, net exports
gross domestic product (GDP) at market prices, the made a positive contribution to growth after a gap of
deceleration in aggregate demand in Q4:2018-19 nine quarters.
Table III.1: Real GDP Growth (Per cent)

Item 2017-18 2018-19 Weighted 2017-18 2018-19 2019-20
(FRE) (PE) Contribution* (FRE) (PE)
2017-18 2018-19 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
Private final consumption expenditure 7.4 8.1 4.2 4.5 10.1 6.0 5.0 8.8 7.3 9.8 8.1 7.2 3.1
Government final consumption expenditure 15.0 9.2 1.5 1.0 21.9 7.6 10.8 21.1 6.6 10.9 6.5 13.1 8.8
Gross fixed capital formation 9.3 10.0 2.9 3.1 3.9 9.3 12.2 11.8 13.3 11.8 11.7 3.6 4.0
Exports 4.7 12.5 1.0 2.5 4.9 5.8 5.3 2.8 10.2 12.7 16.7 10.6 5.7
Imports 17.6 15.4 3.8 3.6 23.9 15.0 15.8 16.2 11.0 22.9 14.5 13.3 4.2
GDP at Market Prices 7.2 6.8 7.2 6.8 6.0 6.8 7.7 8.1 8.0 7.0 6.6 5.8 5.0
FRE: First Revised Estimates; PE: Provisional Estimates.
*: Component-wise contributions to growth do not add up to GDP growth in the table because change in stocks, valuables and discrepancies are not
included.
Source: National Statistical Office (NSO), Government of India.

GDP Projections versus Actual Outcome of lower than expected capital goods production and
The April 2019 MPR had projected real GDP growth of their imports, and moribund activity in construction.
6.8 per cent for Q1:2019-20, with risks evenly balanced III.1.1 Private Final Consumption Expenditure
around the baseline path (Chart III.2). The actual
outcome for the quarter undershot the projections by The unexpected slump in PFCE resulted in its
180 basis points. First, the realised growth in private share falling to 55.1 per cent in Q1:2019-20 from
consumption demand surprised significantly on the 56.1 per cent a year ago. The slowdown in private
downside, indicating that the April 2019 projection consumption was amplified by weak growth in
underestimated the broad-based slowdown in both some of the labour intensive export sectors such as
rural and urban consumption. Second, GFCF growth readymade garments, leather manufactures and jute
also turned out lower than the projection on account manufactures (Chart III.3).

High frequency indicators of urban demand Various indicators of rural demand have also
have weakened in recent months as reflected in remained weak (Chart III.6). Motorcycles and tractor
contraction in sales of passenger vehicles and sales contracted in July and August. Although the
production of consumer durables (Chart III.4). growth of consumer non-durables accelerated in
Among them, passenger car sales have contracted July, it was driven mainly by sunflower oil. The
by double digits every month since April 2019, sales growth of fast moving consumer goods (FMCG)
resulting in major car producers suspending factory companies, a sizeable part of which occurs in rural
production intermittently. A combination of factors areas, has also been sluggish. The reasonably strong
such as higher prices due to stricter safety norms, kharif foodgrains production in the first advance
uncertainty caused by new emission norms and
the proposed switching to electric vehicles have
dented the sales of passenger vehicles (Box III.1).
The growth in household credit for vehicles extended
by banks also moderated (Chart III.5). Domestic
air passenger traffic growth remained modest in
July due to grounding of a private airline, which
impacted air fares and dampened demand; however,
it improved in August. Going forward, passenger
vehicle sales could improve with the government’s
recent support for the sector such as permitting
the operation of Bharat Stage (BS)-IV vehicles
purchased till March 31, 2020, for the entire period
of registration; withdrawal of a ban on the purchase
of new vehicles by government departments; and
deferring the implementation of hike in the one-time
registration fee until June 2020.

Box III.1: Slowdown in the Automobile Sector

The downturn in the automobile sector in India, expected to increase vehicle sales. On the other
which could be attributed to several regulatory and hand, an increase in interest rate is expected to
institutional factors, was accentuated by a slowdown moderate auto sales.
in demand. This has drawn considerable attention X = [zt, pt, d1, d2] is a vector of exogenous variables
in view of the industry’s role in economic activity1. determined from outside the simultaneous system
An estimation framework using vector auto of equations, zt is the y-o-y change in INR/US$
regressions with exogenous variables (Ludvigson, exchange rate, pt is the y-o-y change in diesel
1998) (VARX) was conducted to assess the prices, d1 is a dummy variable representing the
underlying factors for the slump in the auto sector implementation of BS-IV from April 2017. d2
using quarterly data from Q1:2007-08 to Q1:2019- is a dummy variable representing three events
20. In the first VARX (1): which happened during the second half of 2018-
Y = A(L)Y + CX + U, ....(1) 19, viz., liquidity issues faced by non-banking
financial companies (NBFCs) post-IL&FS default,
where Y = [ct, yt, st, it] is a vector of variables
the announcement of axle load norms and
endogenous to the simultaneous system of
implementation of insurance and safety norms. Ut
equations. ct is the credit demand measured as a
is a vector of idiosyncratic errors.
gap between the credit disbursed by scheduled
commercial banks (SCBs) for automobile purchases A similar model was estimated by using the deviation
from its long-term trend. st is the deviation of sales of sales of passenger cars from its long-term trend
of commercial vehicles from its long-term trend. yt instead of sales of commercial vehicles (st) in (1).
is aggregate demand measured as the output gap The key findings emerging from the impulse
and it is the weighted average lending rate of SCBs. response functions (IRFs) from the two VARXs
A rise in aggregate demand and credit demand are (Charts III.I.1) are:
(Contd.)
1
The share of “manufacture of transport equipment” was 12.0 per cent in manufacturing gross value added (GVA) and 2.1 per cent in overall GVA in 2017-18.

(i) both commercial vehicle and passenger car of commercial vehicles positively impact bank
sales are sensitive to aggregate demand shocks; credit flow to the automobile sector.
(ii) both commercial vehicle and passenger car The dummy, representing three events (d2) is
sales respond positively to a decline in interest statistically significant and explains 10 percentage
rates; points of the decline in commercial vehicle sales
(iii)
fuel prices have a negative impact on and 8 percentage points of the decline in passenger
commercial vehicle sales; car sales.
Shocks like the slump in demand, liquidity crisis
(iv) exchange rate depreciation affects auto sales
in the NBFC sector and measures to enhance safety
negatively; and
and security norms, appear to have resulted in a
(v) bank credit does not have any significant downswing in the automobile sector.
impact on vehicle sales; however, the reverse
A slowdown in passenger car sales was also observed
causation is statistically significant, i.e., sales
in the US, the Euro area, China, South Korea and
Japan for a variety of reasons (Chart III.1.2). These
are: (i) stricter emission norms in China and the
Euro area; (ii) mandatory sales of electric vehicles
by car makers in the Euro area; (iii) tepid demand
due to subdued global growth; and (iv) depressed
consumer confidence from escalating US-China
trade tensions.
Reference:
Ludvigson, S. (1998). “The Channel of Monetary
Transmission to Demand: Evidence from the
Market for Automobile Credit”, Journal of Money,
Credit and Banking, 30(3), pp. 365–383.

estimates of the Ministry of Agriculture – only 0.8 per

cent below last year’s level – and bright prospects for
the rabi season in view of soil moisture conditions
and comfortable reservoir levels could buoy rural
incomes and demand, going forward.
III.1.2 Gross Fixed Capital Formation
Growth in gross fixed capital formation (GFCF)
moderated sharply in Q4:2018-19 and Q1:2019-
20 after double digit growth in the five previous
quarters. The share of GFCF in aggregate demand
declined to 32.5 per cent in Q1:2019-20 from 32.8 per
cent a year ago. High frequency indicators suggest
that investment activity remained sluggish in Q2.
Import of capital goods and production of capital
goods contracted in July (Chart III.7). However,
housing loans disbursed by scheduled commercial
banks (SCBs) remained resilient, reflecting the policy
push for the affordable housing sector. Q1:2019-20, while there was some deterioration
Capacity utilisation (CU) in the manufacturing in stalled projects in the government sector in Q1
sector, measured by the order books, inventory and (Chart III.9).
capacity utilisation survey (OBICUS) of the Reserve
Gross capital formation has decelerated since
Bank, moderated to 73.6 per cent in Q1:2019-20 from
76.1 per cent in Q4:2018-19; seasonally adjusted CU, 2011-12 due to a slowdown in investment by
however, improved to 74.8 per cent in Q1:2019-20 the private sector (Chart III.10). Underlying the latter is
from 74.5 per cent in Q4 (Chart III.8). The number corporate deleveraging in select industries as reflected
of stalled projects in the private sector declined in in improving interest coverage ratios (Chart III.11).

The slowdown in investment activity was also April-August 2019, the fiscal position of the central
reflected in a decline in financial flows from banks government strengthened as the gross fiscal deficit
and non-banks to the commercial sector (Chart III.12; (GFD) and revenue deficit (RD) improved vis-à-vis the
see Chapter IV for details). corresponding period of the previous year in terms
III.1.3 Government Expenditure of budget estimates (BE), mainly due to lower growth
Government final consumption expenditure in expenditure (Table III.2). Total expenditure of the
(GFCE) cushioned aggregate demand in Q4:2018-19 central government in the current fiscal year so far
and Q1:2019-20, as pointed out earlier. During has been driven by revenue expenditure.
Table III.2: Key Fiscal Indicators – Central

Government (April-Aug)
(Per cent)
y-o-y
As a per cent of BE
Indicator Growth
2018-19 2019-20 2019-20
1. Revenue receipts 26.9 30.7 29.8
a. Tax revenue (Net) 24.7 24.5 10.5
b. Non-tax revenue 40.1 63.4 102.0
2. Total non-debt receipts 26.4 29.8 29.6
3. Revenue expenditure 43.8 42.5 10.7
4. Capital expenditure 44.0 40.2 3.0
5. Total expenditure 43.8 42.2 9.8
6. Gross fiscal deficit 94.7 78.7 -6.3
7. Revenue deficit 114.0 89.9 -8.1
8. Primary deficit 767.7 773.4 -10.0
BE: Budget Estimates.
Sources: Controller General of Accounts; and Union Budget Document,
2019-20.

In order to meet expenditure commitments, revenue did move closer subsequently, before finally catching
generation is critical. On the receipts side, income tax up in August 2019 (Chart III.14a and 14b). There
collections gained traction during April-August 2019 have, however, been large inter-state variations in
(Chart III.13). SGST collections, with a few states not requiring
Notwithstanding month-over-month fluctuations, the GST compensation cess. Plugging loopholes
the GST collections grew by 4.9 per cent (y-o-y) during and mitigating information technology (IT) glitches
April-September 2019. The share of State GST (SGST) such as putting in place an invoice-matching system
collections in total GST revenue has been sizably to facilitate a system validated input tax credit,
higher than Central GST (CGST), attributable to the overcoming operational deficiencies of the payment
adjustment for input tax credit. After apportionment module, alignment of system validations with the
of integrated GST (IGST) collections, the share of GST Acts and Rules along with alleviating system
CGST collections remained significantly lower than design deficiencies may facilitate tapping of GST
SGST collections during April-September 2018. They potential.2
2
Report of Comptroller and Auditor General of India on Indirect Taxes – Goods and Services Tax for the year ended March 2018, Report No. 11, July, 2019.

Non-tax revenue has been an important source of of the capital expenditure multiplier (RBI, 2019).3
finance for the central government. During April- A major challenge for government finances in the
August 2019, this component witnessed robust growth remaining period of the current financial year is to
driven by the surplus transfer from the Reserve Bank. adhere to the budgeted capital spending and revenue
Resource mobilising efforts through disinvestment generation targets.
may also help garner revenues, going forward. As regards direct taxes of states, stamp duty collections
On the expenditure front, both revenue and capital are highly correlated with construction activity
expenditure of the central government witnessed (Chart III.16). Hence, a slowdown in the construction
some moderation in Q1:2019-20. However, after the sector might impact stamp duty collections.
declaration of election results, both revenue and After remaining above 6 per cent of GDP between
capital expenditure picked up significantly during 2008-09 to 2016-17, the combined GFD of the centre
July-August 2019; almost 40 per cent of budgeted and states dropped below 6 per cent in 2017-18. It
capital expenditure for roads and highways was is estimated at 6.2 per cent in 2018-19 (RE) and 5.9
incurred in the month of July 2019. Likewise, per cent in 2019-20 (BE). Outstanding liabilities of
information available for 22 states indicates a the general government are budgeted to marginally
slowdown in revenue expenditure in Q1:2019-20 decline to 69.6 per cent of GDP in 2019-20 from 69.8
though it picked up in July 2019. per cent in 2018-19, driven by the centre, though
states’ debt is showing a rising trend. The debt
States have reduced their capital spending in order
servicing capacity of the general government has
to adhere to fiscal deficit targets in the last few years
improved in 2018-19 with the interest payments as
(Chart III.15). This seems to have, in turn, affected
per cent to revenue receipts exhibiting a decline.
investment adversely. Going forward, a pick-up in
capital spending by both the centre and states is The Reserve Bank has managed the centre’s market
desirable given the growth augmenting property borrowing programme during 2019-20 so far as
3
Reserve Bank of India (2019), “Estimable Fiscal Multipliers for India”, Monetary Policy Report, pp. 35-37, April.

Table III.3: Government Market Borrowings

(₹ crore)
2017-18 2018-19 2019-20 (September 30, 2019)

Item
Centre States Total Centre States Total Centre States Total
Net borrowings 4,48,410 3,40,281 7,88,691 4,22,737 3,48,643 7,71,380 3,40,972 1,56,447 4,97,419
Gross borrowings 5,88,000 4,19,100 10,07,100 5,71,000 4,78,323 10,49,323 4,42,000 2,25,445 6,67,445
Sources: Government of India and RBI staff estimates.
per the planned issuance schedule. The budgeted Q2:2016-17, as slowdown in import growth was more
gross market borrowing of the central government pronounced than that for exports.
for 2019-20 at ₹7,10,000 crore is about 24.3 per
The persisting loss of momentum in global trade
cent higher than last year. The central government
impacted India’s merchandise exports, which
completed 62.3 per cent of its budgeted gross
contracted during Q1:2019-20 and in July-August
market borrowings as on September 30, 2019 (50.4
2019-20 in both the petroleum, oil and lubricants
per cent in the corresponding period of 2018-19)
(POL) and non-POL categories (Chart III.17a). The
(Table III.3). The Union Budget 2019-20 provides for
sectors which contributed to the overall decline
consolidation measures like switching of securities
included engineering goods, gems and jewellery and
budgeted at ₹50,000 crore, of which ₹40,109 crore
rice. POL exports declined mainly on account of a fall
worth of securities have already been switched. The
in international crude oil prices. In addition, routine
states completed 35.6 per cent of their budgeted
maintenance-related shutdowns in major refineries
gross market borrowings till September 30, 2019 as
adversely impacted exports in June 2019 (Chart
compared with 27.6 per cent in the corresponding
III.18a).
period of 2018-19. A major part of market borrowings
by the states is expected to occur in H2:2019-20. Imports also contracted in Q1:2019-20 due to
deceleration in POL growth and decline in non-POL
III.1.4 External Demand
non-gold imports. Gold imports surged on the back of a
Net exports contributed positively to aggregate decline in prices, wedding and festive season demand
demand in Q1:2019-20 for the first time after during Q1:2019-20 (Chart III.18b). The decline in non-

POL non-gold imports was broad-based as imports account increased due to higher dividends on foreign
of transport equipment, pearls and precious stones, investment in Q1:2019-20.
metalliferous ores and vegetable oil contracted.
The CAD was comfortably met by a mix of foreign direct
Imports continued to contract in July-August 2019 in
investment (FDI), foreign portfolio investment (FPI)
a broad-based manner. The trade deficit moderated
and external commercial borrowings in Q1:2019-20
from US$ 46.7 billion in Q1:2018-19 to US$ 46.2 billion
with net accretion to reserves to the tune of US$
in Q1:2019-20, although on a sequential basis, i.e.,
14.0 billion. Higher FPI flows, including under the
Q1:2019-20 over Q4:2018-19, it expanded modestly.
voluntary retention route (VRR) introduced in March
However, with imports declining faster than exports,
2019, eased external financing conditions. Net inflows
the trade deficit narrowed from US$ 36.5 billion
under external commercial borrowings to India stood
in July-August 2018-19 to US$ 26.9 billion in the
at US$ 6.3 billion in Q1:2019-20 as against an outflow
corresponding period of 2019-20. While the current
of US$ 1.5 billion a year ago. Net FDI flows at US$
account deficit (CAD) mirrored the movements in
13.9 billion in Q1:2019-20 were higher than US$ 9.6
the trade deficit, both on a y-o-y and sequential basis,
CAD as per cent of GDP widened to 2 per cent in billion a year ago. Easing of norms for FDI in single
Q1:2019-20 from below one per cent in Q4:2018-19. brand retail, contract manufacturing, and coal mining
More than 80 per cent of the trade deficit was financed are likely to give a push to FDI inflows and strengthen
through invisibles, i.e., net export of services and India’s participation in the global value chain.
remittances. Net services exports grew by 7.3 per cent Notwithstanding outflows from the equity segment
in Q1:2019-20 on a y-o-y basis – primarily driven by in July and August 2019, net FPI purchases (excluding
software, travel and financial services (Chart III.17b). VRR) in the domestic capital market were at US$ 3.3
Revenue growth of major information technology billion during April-September 2019 as against an
(IT) companies making software exports, improved outflow of US$ 11.5 billion a year ago. Net flows
on a y-o-y basis in Q1:2019-20; an increase of 0.6 under non-resident deposits were robust in Q1:2019-
per cent in total global IT spending is projected in 20. India’s forex exchange reserves were placed at
2019. Remittances remained stronger in Q1:2019- US$ 434.6 billion on October 1, 2019 – an increase
20, though the net outgo of payments under income of US$21.7 billion over the level at end-March 2019.

III.2 Aggregate Supply
On the supply side, the gross value added (GVA)

growth decelerated to 5.7 per cent in Q4:2018-19 and
further to a twenty-one-quarter low of 4.9 per cent in
Q1:2019-20 (Table III.4). GVA momentum, measured in
terms of seasonally adjusted q-o-q annualised growth,
also declined sharply in Q1 (Chart III.19).
The deceleration in GVA growth (y-o-y) was caused

by a significant deceleration in services growth to 6.7
per cent in Q1:2019-20 from 8.2 per cent in Q4:2018-
19, pulled down by construction and ‘financial, real
estate and professional services’. Manufacturing
registered the second lowest growth in the 2011-
12 series4. Despite some deceleration, public
administration, defence and other services (PADO)
III.2.1 Agriculture
grew at a healthy rate. Excluding PADO, the GVA
growth would have slipped to 5.0 per cent in Q4:2018- In Q1:2019-20, value added in agriculture and allied
19 and 4.5 per cent in Q1:2019-20 (Chart III.20). activities recovered from contraction in the preceding
Growth in ‘trade, hotels, transport, communication quarter on the back of higher production of wheat
and services related to broadcasting’ registered an and oilseeds during the rabi season. This was also
uptick sequentially. supported by higher horticulture production by 0.7
Table III.4: Sector-wise Growth in GVA

(y-o-y, per cent)
Sector 2017-18 2018-19 Weighted 2017-18 (FRE) 2018-19 2019-

(FRE) (PE) Contribution (PE) 20
2017-18 2018-19 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
Agriculture, forestry and fishing 5.0 2.9 0.8 0.4 4.2 4.5 4.6 6.5 5.1 4.9 2.8 -0.1 2.0
Industry 6.1 6.2 1.4 1.4 -0.1 7.7 8.0 8.6 9.9 6.1 6.0 3.4 1.7
Mining and quarrying 5.1 1.3 0.2 0.0 2.9 10.8 4.5 3.8 0.4 -2.2 1.8 4.2 2.7
Manufacturing 5.9 6.9 1.1 1.2 -1.7 7.1 8.6 9.5 12.1 6.9 6.4 3.1 0.6
Electricity, gas, water supply and other utilities 8.6 7.0 0.2 0.2 8.6 9.2 7.5 9.2 6.7 8.7 8.3 4.3 8.6
Services 7.8 7.7 4.8 4.8 8.6 6.5 8.0 8.0 7.5 7.5 7.6 8.2 6.7
Construction 5.6 8.7 0.5 0.7 3.3 4.8 8.0 6.4 9.6 8.5 9.7 7.1 5.7
Trade, hotels, transport, communication 7.8 6.9 1.5 1.3 8.3 8.3 8.3 6.4 7.8 6.9 6.9 6.0 7.1
Financial, real estate and professional services 6.2 7.4 1.4 1.6 7.8 4.8 6.8 5.5 6.5 7.0 7.2 9.5 5.9
Public administration, defence and other services 11.9 8.6 1.5 1.1 14.8 8.8 9.2 15.2 7.5 8.6 7.5 10.7 8.5
GVA at basic prices 6.9 6.6 6.9 6.6 5.9 6.6 7.3 7.9 7.7 6.9 6.3 5.7 4.9
FRE: First Revised Estimates; PE: Provisional Estimates.

Source: NSO.
4
The lowest growth in manufacturing was recorded in Q1:2017-18 possibly due to the transient impact of the implementation of the goods and services
tax (GST).

per cent to a record of 3,138 lakh tonnes, as per the comparison with 9 per cent below the LPA last year.
third advance estimates for 2018-19. In terms of distribution, 12 sub-divisions (compared
to 1 sub-division last year) received excess rainfall, 19
The fourth advance estimates of agricultural
received normal rainfall (23 sub-divisions last year),
production for 2018-19 released in August placed
and 5 suffered deficient rainfall (12 sub-divisions last
foodgrains production at 2,850 lakh tonnes – same
year) (Chart III.22). Abundant rains between mid-
as the final estimate of 2017-18 for the previous year,
August and September augmented the live storage
but lower than the target of 2,903 lakh tonnes for the
available in 113 reservoirs (as on September 26, 2019)
year. Poor performance of south-west and north-east
monsoon impacted crop production during 2018-
19, particularly in the rabi season with most of the
crops missing their respective targets set for the
year. Nevertheless, production of rice, wheat and
sugarcane touched a record high in 2018-19.
In 2019, the south-west monsoon started with a

week’s delay and its progress across southern and
central India was hindered by cyclone Vayu. As a
result, there was a rainfall deficit of 36 per cent below
the Long Period Average (LPA) in June. The monsoon
gained momentum from July. Heavy rainfall in the
beginning of the month reduced the cumulative deficit
to 9 per cent below the LPA by the end of the month
(Chart III.21). The cumulative all-India rainfall as on
September 30, 2019 was 10 per cent above the LPA in

with the cumulative reservoir level at 115 per cent of 9.5 per cent lower as on June 28, 2019 than a year
the live storage in the corresponding period of the ago. However, sowing recovered thereafter, with an
previous year. improvement in precipitation across the country and
announcement of minimum support prices (MSPs)
The production weighted rainfall index5 (PRN) was for kharif crops. As a result, the total area sown caught
also higher than a year ago and was ‘normal’ or up with last year’s average as on September 27, 2019
‘above normal’ for all the major crops, barring rice (Chart III.24a). At a disaggregated level, sowing caught
(Chart III.23). up across all crops, exceeding last year’s levels in
Reflecting the initial delay in the onset of the respect of cotton and pulses (Chart III.24b).
monsoon, kharif sowing started on a low note with The first advance estimates of production of
acreage for most crops lagging behind the area sown major kharif crops for 2019-20 have placed foodgrains
last year. The total area sown under kharif crops was production at 1,406 lakh tonnes, 0.8 per cent lower
5
The All India production-weighted rainfall index (PRN) for a crop (total foodgrains) is constructed as a ratio of the weighted averages of state-wise actual
rainfall and IMD normal rainfall, expressed as a percentage. The weights used are based on five year average shares of the state-wise crop (total foodgrains)
production.

than last year’s level, reflecting the delayed onset III.2.2 Industry

of monsoon and intense rains and floods in various
The slowdown in industrial activity that set in
states. However, among the commercial crops,
from Q2:2018-19 deepened further in Q1:2019-20
the production of oil seeds, cotton, jute and mesta
(Chart III.25). A sharp deceleration in manufacturing
has been estimated to be higher than last year’s
GVA in Q1:2019-20 essentially reflected weaknesses
production.
in the organised sector. In terms of the index of
The MSPs announced for the kharif season 2019-20
industrial production (IIP)7, however, the performance
ensure a return of at least 50 per cent over the cost
of manufacturing improved in Q1:2019-20 from
of production (as measured by A2 plus FL6) for all
the previous quarter. In July, manufacturing output
the crops (Table III.5). However, the growth in MSP
accelerated further (Chart III.26).
in 2019-20 for kharif crops over last year’s level of
support price was modest (in the range of 1.1-9.2 per In terms of the use-based classification, the
cent) as compared with a range of 3.7-52.5 per cent in intermediate goods sector grew by double digits for the
2018-19. While the highest increase in the MSP was third consecutive month in July 2019, mainly driven by
for soyabean (9.2 per cent), followed by ragi (8.7 per mild steel slabs. Consumer non-durables growth also
cent), the lowest was for niger seeds and moong (1.1 accelerated, supported by sunflower oil production.
per cent). However, the capital goods sector contracted for the
Table III.5. Minimum Support Price – Kharif Season Crops

`/Quintal Growth Rate (per cent) Return Return in
Crop in 2018-19 over 2019-20 over
2017-18 2018-19 2019-20 2018-19 over 2019-20 over Cost (per cent) Cost (per cent)
2017-18 2018-19
Paddy common 1550 1750 1815 12.9 3.7 50.1 50.2
Paddy (F)/Grade’A’ 1590 1770 1835 11.3 3.7 51.8 51.9
Jowar-Hybrid 1700 2430 2550 42.9 4.9 50.1 50.2
Jowar-Maldandi 1725 2450 2570 42.0 4.9 51.3 51.4
Bajra 1425 1950 2000 36.8 2.6 97.0 84.7
Ragi 1900 2897 3150 52.5 8.7 50.0 50.0
Maize 1425 1700 1760 19.3 3.5 50.3 50.3
Tur (Arhar) 5450 5675 5800 4.1 2.2 65.4 59.5
Moong 5575 6975 7050 25.1 1.1 50.0 50.0
Urad 5400 5600 5700 3.7 1.8 62.9 63.9
Groundnut 4450 4890 5090 9.9 4.1 50.0 50.0
Sunflower seed 4100 5388 5650 31.4 4.9 50.0 50.0
Soyabean yellow 3050 3399 3710 11.4 9.2 50.0 50.0
Sesamum 5300 6249 6485 17.9 3.8 50.0 50.0
Niger seed 4050 5877 5940 45.1 1.1 50.0 50.0
Medium staple cotton 4020 5150 5255 28.1 2.0 50.0 50.1
Long staple cotton 4320 5450 5550 26.2 1.8 58.8 58.5
Source: Ministry of Agriculture and Farmers’ Welfare, Government of India.
6
A2 plus FL includes all paid out costs such as expenses on hired labour, machines, rent paid for leased land, seeds, fertilisers, irrigation charges, depreciation
as well as imputed value of family labour.
7
IIP at the appropriate digit level is taken into account to represent the unorganised manufacturing sector in the quarterly GVA estimates.

seventh successive month, caused by contraction in sources was lower in July and August on a y-o-y basis
commercial vehicles, tractors and printing machinery. (Charts III.28).
The consumer durables segment contracted for two The deceleration in manufacturing GVA in Q1:2019-20
consecutive months, pulled down by a decline in the was also reflected in sales growth of manufacturing
production of passenger vehicles, auto components companies, pulled down mainly by lower sales
and two-wheelers (Chart III.27). of automobiles, petroleum, and iron and steel
(Chart III. 29). The slowdown in sales also mirrored
Electricity generation accelerated in Q1:2019-20 in a sharp decline in profit before tax (Chart III. 30).
due to increased summer demand following the A silver lining was witnessed in the sales of cement,
delayed onset of the monsoon. With the seasonal pharmaceuticals and chemical companies, which
pressure abating, electricity generation from various continued to grow in Q1:2019-20.

Overall business sentiment in the Indian and fall in profit margins of the surveyed firms.
manufacturing sector has deteriorated recently. Business expectations index (BEI) also moderated to
The business assessment index (BAI) fell to 92.5 in 102.2 in Q3:2019-20 (from 112.8 in Q2:2019-20). The
Q2:2019-20 (from 108.4 in Q1:2019-20) in the 87th manufacturing purchasing managers’ index (PMI)
round of the Reserve Bank’s Industrial Outlook for September 2019 was unchanged at its previous
Survey (IOS) due to a decline in new orders, month level, while new orders and employment
contraction in production, lower capacity utilisation improved, albeit, marginally, new export orders
declined.
III.2.3 Services
In Q1:2019-20, services sector growth was the lowest

in the last seven quarters, pulled down by financial,
real estate and professional services, and construction
activity. PADO grew at a healthy rate in Q1:2019-20
and cushioned the loss of pace of GVA from overall
services. ‘Trade, hotels, transport, communication
and services related to broadcasting’ maintained
momentum, though transport services indicators
have weakened significantly in the recent period. The
sales of commercial vehicles, passenger vehicles, and
two-wheelers contracted sharply in July-August.
Growth in domestic air passenger traffic accelerated
in August. While rail freight traffic contracted in July,

domestic air cargo traffic growth improved in August PADO growth moderated sequentially in Q1:2019-
(Chart III.31a and b). The services PMI, however, 20, reflecting subdued revenue expenditure (net
expanded in July and August, reversing the of interest payments and subsidies) of the union
contraction in June. and the state governments ahead of elections. The
Of the two key indicators of construction activity, growth of ‘financial, real estate and professional
the production of cement accelerated sharply in July services’ decelerated in Q1:2019-20 mainly due to
before contracting in August, while finished steel the poor performance by listed real estate companies
consumption moderated in July-August (Chart III.32). notwithstanding a healthy growth in financial
Softer domestic steel prices are likely to strengthen services (Chart III.33).
steel consumption, going forward.

In the residential real estate sector, both sales and gap – measured by the deviation of actual output
new launches contracted in Q1:2019-20, indicating from its potential level and expressed as a ratio of
sluggish demand (Chart III.34a). With sales outpacing potential output – provides a summary measure
new launches, the inventory overhang has declined of demand-supply conditions in the economy.
somewhat, though the large inventory overhang still Since potential output and the output gap are both
has a moderating influence on residential house unobservable and their estimates can be sensitive
prices (Chart III.34b). to the choice of methodology and data availability,
a pragmatic approach has been followed by applying
III.3. Output Gap
several methods to estimate potential output. The
A detailed analysis of aggregate demand and aggregate methods followed are univariate filters such as the
supply in the above sections provides an assessment Hodrick-Prescott (HP) filter, the Baxter-King (BK) filter
of the state of the economy in H1:2019-20. The output and the Christiano-Fitzgerald (CF) filter on the one
hand, and multivariate Kalman filter (MVKF) taking
into account inflation developments, on the other, to
draw robust inferences on the state of the business
cycle (Chart III.35). The composite estimate arrived
by combining all these measures suggests that the
output gap has turned more negative.
III.4. Conclusion
A combination of domestic and global headwinds has
depressed economic activity, especially in terms of
aggregate demand. The near-term outlook of the Indian
economy is fraught with several risks. First, private
consumption, which all along supported economic
activity, is now beginning to slow down due to a host
of factors. In this context, the performance of large
employment generating sectors such as automobile

and real estate remains less than satisfactory. Recent global uncertainties have weakened investment
measures initiated such as the sharp cut in corporate activity at home. Further escalation of trade tensions
tax rates, stressed assets funds for the housing sector, could adversely impact export prospects, besides
infrastructure investment funds, implementation of delaying the investment upturn. The private corporate
a fully electronic GST refund system and funds for sector has not been adding new capacities even as
export guarantee would be helpful. Second, bank credit existing capacity utilisation has risen close to its long-
growth has slowed down and overall fund flows to the term average for several quarters. The recent measures
commercial sector have declined, partly due to risk should help kickstart the capex cycle so that new
aversion and partly due to a slowdown in demand. The capacities can come on stream and lead to the
recent recapitalisation of public sector banks augurs strengthening of domestic demand in the short-term
well for improving credit flows, which are important while boosting the medium-term growth potential of
for reviving private investment activity. Meanwhile, the economy.

IV. Financial Markets and evolving domestic and global developments in

H1:2019-20. While money markets witnessed swift
Liquidity Conditions and complete transmission, the moderation of
yields in bond markets was interrupted by domestic
Domestic financial market segments reacted to evolving
and international factors in August. Equity markets
domestic and global developments in a diverse manner
made handsome gains in Q1, with the election
in the first half of 2019-20. While money markets
related uncertainty coming to an end, but suffered
experienced swift and complete transmission of policy
losses on geo-political developments, poor corporate
impulses, the government securities and foreign exchange
performance and weakness in macroeconomic
market segments were impacted by domestic economic
slowdown and global spillovers. The stock market indicators in Q2. Rising global uncertainty amidst
intermittently scaled new highs amidst sell-off pressures geo-political tensions and domestic cyclical downturn
from geo-political tensions. In the credit market, bank in the economy adversely impacted the foreign
lending decelerated reflecting weak demand and risk exchange market. Overall flow of financial resources
aversion. to the commercial sector moderated mainly due to
reduced credit offtake from banks reflecting weak
Global financial markets were on edge through the first demand and risk aversion.
half of 2019-20 (H1:2019-20) amidst sporadic bouts
IV.1.1 Money Market
of turbulence around trade tensions, geo-political
flashpoints, uncertainty surrounding a chaotic Brexit During H1:2019-20, various segments of the money
and a subdued global growth outlook, despite dovish market were impacted by the RBI’s monetary policy
monetary policy stances of leading central banks. actions, stance and liquidity conditions. In the
Equity markets, in particular, experienced high overnight money market, the weighted average call
volatility with stocks of emerging market economies rate (WACR) generally remained below the policy repo
(EMEs) undergoing sell-offs on fears of political unrest rate during H1:2019-20, trading with a downward bias
in Hong Kong and debt default concerns in Argentina. (see Section IV.3 for details). The spread between the
In bond markets, corporate credit spreads widened as WACR and the policy repo rate widened from June,
global growth prospects dimmed; on the other hand, and averaged 6 bps in September. Other overnight
ebbing risk appetite coupled with accommodative money market rates in the collateralised segment,
monetary policy stances resulted in softening of i.e., the tri-party repo rate and the market repo rate,
sovereign yields across AEs and EMEs. In the currency moved largely in tandem with the WACR. Both the
market, the US dollar continued to appreciate against tri-party repo rate and the market repo rate remained
other major currencies, reflecting relatively stronger below the WACR by 7 bps during H1:2019-20 on an
US macroeconomic fundamentals. EME currencies average.
depreciated amidst mounting spillover risks arising
Volumes in the inter-bank money market shifted
from trade tensions and market turmoil.
from the uncollateralised to the collateralised
IV.1 Domestic Financial Markets segment during H1:2019-20. The progressive easing
Various segments of the domestic financial market of liquidity conditions led to a fall in the share of
exhibited divergent movements in response to call money in total overnight money market volume.

Concomitantly, the share of tri-party repo and market to policy rate cuts and the shift in the policy stance
repo in total money market volumes increased from neutral to accommodative during H1:2019-
(Chart IV.1).1 20 (Chart IV.2). Interest rates on CPs moderated
noticeably during H1, particularly those issued by
In terms of market microstructure, mutual funds
non-banking financial companies (NBFCs), although
(MFs) continued to be the major lenders in the tri-
party repo and market repo segments, with average CP rates traded above CD rates. In comparison, yields
shares of 59 per cent and 39 per cent, respectively, in on 3-month T-bills moderated by a greater extent
H1:2019-20. The major borrowers were public sector during the period.
banks in the tri-party repo segment and primary In the wake of easy liquidity conditions in the
dealers (PDs) in the market repo segment. Given banking system, fresh issuances of CDs declined to
deficit liquidity conditions in April and May, lending ₹1,75,305 crore during H1:2019-20 (up to September
by MFs declined while borrowing by MFs increased in 13, 2019) as compared with ₹1,98,829 crore during the
the collateralised segment during these two months. corresponding period of 2018-19. Primary issuances
With systemic liquidity turning surplus since June, of CPs also declined to ₹11,92,277 crore during
lending by MFs increased while borrowing declined H1:2019-20 from ₹13,58,117 crore during H1:2018-
marginally in the collateralised segment during June- 19, with more than 99 per cent of the issuances by
September.
companies with A1+ rating. CP issuances moderated
Interest rates on longer-term money market from July reflecting heightened risk aversion in view
instruments such as certificates of deposit (CDs), of downgrading of a few CP issuers in June and July
commercial papers (CPs) and Treasury Bills (T-bills) 2019. Nevertheless, interest rates in the primary
of 3-month maturity responded in varying degrees CP market – as reflected in the weighted average
1
In the call money market, participants include banks and primary dealers discount rate (WADR) – moderated sharply by 130
only, while other market participants such as mutual funds, insurance bps during H1:2019-20, facilitated by the easing of
companies and other financial institutions are the key players in the tri-party
repo and market repo segments. liquidity conditions (Chart IV.3a). During this period,

non-financial corporates and NBFCs were the major in liquidity conditions from deficit to surplus since
issuers in the CP market (Chart IV.3b). the beginning of June 2019; (ii) the predominance
Risk premium in the money market (i.e., spread of issuances by top rated issuers raising funds at
between 3-month CPs and 3-month T-bills) remained competitive rates; and (iii) the measures taken by the
high at an average of 99 bps during April-July reflecting government and the Reserve Bank to provide liquidity
the downgrading of some CP issuers in June-July and support to NBFCs.2 The spread between 3-month CP
tight liquidity conditions during April-May (Chart rate of NBFCs and non-NBFCs narrowed (average of
IV.4a). The risk premium declined sharply to an 23 bps in H1:2019-20 vis-à-vis 44 bps in H2:2018-19),
average of 64 bps in August-September on account notwithstanding some intermittent spikes (Chart
of (i) the liquidity effect emanating from the switch IV.4b).
2
The Union Budget on July 5, 2019 announced that the government would provide a one-time partial credit guarantee to public sector banks to buy high-
rated pooled assets worth ₹1 lakh crore from NBFCs. Moreover, the Reserve Bank in its bi-monthly monetary policy of August 2019 allowed bank lending
to NBFCs for on-lending to agriculture, micro and small enterprises, and housing to be classified as priority sector lending, up to specified limits. The RBI
also liberalised the external commercial borrowings framework, which facilitated NBFCs to raise funds for on-lending and repayment of rupee loans.

Table IV.1: Policy Transmission in the Money Market

(Basis points)
Change in Rates
H1: 2019-20 Repo WACR Tri-party Market Repo 3-month CD 91-day 3-month
Repo T-bill CP (NBFCs)
April 3 to June 4 -25 -32 -43 -37 -33 -16 -5

June 6 to August 6 -25 -24 -18 -25 -48 -44 -80
August 7 to September 30 -35 -23 -28 -32 -6 -38 20
Cumulative (April 3 - September 30) -85 -79 -89 -94 -87 -98 -65
Sources: RBI; CCIL; FBIL; and Bloomberg.
During H1:2019-20, policy transmission was nearly Amidst heightened trade tensions, yields softened
complete in all segments of the money market. Of by 38 bps by during May in the wake of election
the three policy announcements during this period, results indicating political stability. This was aided
the maximum impact was felt after the June policy by infusion of liquidity through open market
– which signaled both a rate cut and a change in the operation (OMO) purchases and lower crude oil
stance from neutral to accommodative – particularly prices. The softening trend continued in June with
at the longer end of the money market spectrum the benchmark yield declining further by 15 bps
(Table IV.1). Thus, both the announcement effect during the month, as market sentiment was buoyed
of repo rate cuts and the liquidity effect of surplus by a further reduction in the policy rate, a shift in
conditions were instrumental in securing policy the policy stance and continued OMO purchases by
transmission. the RBI.
IV.1.2 Government Securities (G-Sec) Market The moderation in yields extended into Q2 even
G-sec yields traded with a softening bias at the as the market sentiment was unsettled by fears of
beginning of Q1:2019-20, taking cues from several excess supply of paper. In fact, G-Sec yields remained
positive developments during Q4:2018-19, viz., volatile through July 2019. Nonetheless, positive
monetary policy easing and a change in the policy Budget announcements such as pegging of the
stance from calibrated tightening to neutral; fiscal deficit at 3.3 per cent of GDP and unchanged
injection of durable liquidity; announcement of quantum of borrowing vis-à-vis the Interim Budget
the voluntary retention route (VRR); and successive bolstered market sentiment. This was also reflected
benign inflation prints. The softening of yields was, in renewed buying by foreign portfolio investors
however, ephemeral and they started hardening in (FPIs) in the debt market. Moreover, benign inflation
April 2019, partly due to (i) no change in the policy prints triggered market expectations of further rate
stance contrary to market expectation; (ii) sustained cuts. All these factors resulted in the benchmark yield
higher crude oil prices after the US announced softening further by 50 bps during July, touching a
stopping of imports from Iran and supply disruptions low of 6.33 per cent on July 16, 2019 – its lowest level
in Libya and Venezuela; and (iii) depreciation of the during H1:2019-20. Despite positive developments
Indian rupee (INR). Consequently, the benchmark such as a larger than expected rate cut of 35 bps
yield hardened by 6 bps during April 2019 despite by the MPC, rollback of surcharge on FPIs, higher
injection of durable liquidity through a US dollar buy/ than expected surplus transfer by the RBI, the G-sec
sell swap. market remained wary in August on concerns over

bond yields. Subsequent reassurances by the

Saudi authorities on restoring normalcy assuaged
market apprehensions somewhat and softened
crude prices thereafter. Moreover, large buying
support from state owned banks, market expectation
of a further rate cut and easing of limit on foreign
investment in gilts softened yields towards the end
of September. Overall, the benchmark yield softened
by 65 bps during H1:2019-20, closing at 6.70 per cent
on September 30, 2019.
The yield curve, which underwent shifts in
H1:2019-20, is characterised by its level and slope
(Chart IV.6a).3 Since the April monetary policy
announcement, the average level of yield has
softened by 50 bps, driven down by: (i) cumulative
policy easing by 85 bps, accompanied by a change in
fiscal slippage arising from anticipation of a stimulus, the monetary policy stance; (ii) build-up of surplus
and domestic/geo-political tensions. Accordingly, the liquidity position aided by liquidity infusion through
OMOs and forex buy/sell swaps; (iii) ongoing
benchmark yield hardened by 19 bps during August
liquidity support measures to NBFCs; and (iv) benign
2019, paring previous gains (Chart IV.5).
domestic inflation prints. Since the August policy
The hardening bias of benchmark yield continued announcement (up to September 30, 2019), however,
in September owing to (i) rising crude oil prices the average level has firmed up by 24 bps even as
following the attack on Saudi oil refineries; (ii) the yield curve has become steeper, reflecting inter
lingering fiscal concerns; and (iii) surge in overnight alia fears of a large shortfall in government revenue
indexed swap (OIS) rates fuelled by a rise in US after the announcement of corporate tax rate cuts by
3
While the level is the average of all yields across maturities, the slope is represented by the difference in yield between the longest and the shortest
maturity (term spread).

the Government, apprehensions of crude oil supply

disruption and heightened geo-political uncertainties/
financial market turmoil in some EMEs (Chart IV.6b).
The introduction of the VRR and increased investment
limits for G-Sec boosted overseas investor interest in
debt instruments at the beginning of 2019-20. With
benign inflation prints, coupled with political stability
arousing investors’ appetite, FPIs remained net buyers
in the G-Sec market during H1:2019-20, although they
turned net sellers in September due to geo-political
tensions and tepid domestic economic outlook (Chart
IV.7). At the short end of the primary segment, T-bill
yields softened during H1:2019-20 tracking the
benchmark yield (Chart IV.8).
At the longer end, issuances of state development
loans (SDLs) were moderate during H1:2019-20 as IV.1.3 Corporate Bond Market
against the front-loading of issuances by the GoI. The
weighted average cumulative spread of SDLs’ cut- Corporate bond yields eased sharply during H1:2019-
offs over the corresponding tenor G-sec at 52 bps in 20, largely tracking G-sec yields and reflecting
H1:2019-20 (as on September 30) was comparable to transmission of policy repo rate cuts (Chart IV.10a).
54 bps in H1:2018-19 (Chart IV.9). During H1:2019-20, During this period, 5-year AAA corporate bond
the average inter-state spread on securities of 10-year yields softened by 66 basis points – from 8.10 per
tenor at 4 bps remained identical to that recorded in cent at end-March 2019 to 7.44 per cent at end-
H1:2018-19. September 2019 – in response to the cumulative

policy rate reduction of 85 basis points (excluding the crore during H1:2019-20 (up to September 27, 2019)
reduction in February 2019 during the current easing from ₹7,131 crore during H1:2018-19.
cycle). Moreover, easy liquidity conditions also led
IV.1.4 Equity Market
to a reduction in the risk premia. Illustratively, the
yield spread (5-year AAA corporate bonds over 5-year Equity markets scaled records in the immediate
G-sec) on bonds issued by public sector undertakings aftermath of the 2019 general elections. Thereafter,
(PSUs), financial institutions (FIs) and banks, they corrected during Q2:2019-20 due to a combination
NBFCs, and corporates declined by 32 bps, 20 bps of domestic and global factors which dampened
and 19 bps points, respectively, during this period. market sentiment, closing at about the same level as
State Bank of India (SBI) and ICICI Bank 5-year credit at the beginning of the year (Chart IV.11a).
default swap (CDS) spreads – which indicate credit The BSE Sensex registered modest gains in April
default risk – also declined by 23 bps and 21 bps, 2019, aided by continued FPI inflows, the policy
respectively. repo rate cut by the RBI and positive global cues,
Resource mobilisation through issuances of corporate notwithstanding weak corporate earnings results.
bonds in the primary market increased sharply by 34.4 Markets witnessed a sharp downturn during early
per cent to ₹2.6 lakh crore during April-August 2019 May 2019 as trade tensions between the US and China
from ₹1.9 lakh crore a year ago (Chart IV.10b). Almost intensified. Investor sentiment, however, turned
the entire resource mobilisation in the corporate positive later in the month buoyed by the prospects
bond market (97.3 per cent) continued to be through of a stable government and expectations of further
the private placement route. Investments by FPIs in monetary easing by the RBI.
corporate bonds declined to ₹2.03 lakh crore at end- Market exuberance pushed the BSE Sensex to a
September 2019 from ₹2.19 lakh crore at end-March record high of 40268 on June 3, 2019 but this rally
2019. Consequently, FPIs’ utilisation of the approved proved transient as sentiment turned bearish after
limit for investment in corporate bonds came down a default by a housing finance company triggered
to 64.0 per cent at end-September 2019 from 75.9 per liquidity concerns in the NBFC sector. The downtrend
cent at end-March 2019. The average daily turnover deepened in July over some Budget proposals such
in the corporate bond market increased to ₹8,261 as (i) tax on super rich; (ii) buyback tax; and (iii)

increase in minimum public shareholding in listed While FPIs were net sellers to the tune of ₹605 crore in
companies. Negative cues from global equity markets, the equity market, domestic institutional investors,
reporting of a borrowing fraud in a public sector bank, particularly MFs, made heavy purchases amounting
concerns over lackluster corporate earnings results to ₹50,316 crore during H1: 2019-20 (Chart IV.11b). In
for Q1: 2019-20, slow progress of the monsoon and the primary segment of the equity market, resource
continued FPI outflows due to the proposed increase mobilisation through public and rights issues grew
in tax surcharge for FPIs registered as non-corporates nearly five times to ₹59,618 crore during April-
August 2019 as compared with ₹12,028 crore in the
exacerbated the decline in July 2019.
corresponding period of the previous year.
The equity market declined marginally in August
IV.1.5 Foreign Exchange Market
2019. Adverse domestic developments such as tepid
corporate earnings results for Q1: 2019-20, lukewarm Since April 2019, the INR traded with a depreciating
industrial activity and auto sales, and negative global bias, dipping to a low of ₹72.19 per US dollar (reference
cues, viz., political unrest in Hong Kong, debt default rate) on September 3, 2019. The fall in the INR was
in line with many EME currencies experiencing
in Argentina and uncertainty over the US-China
depreciation vis-à-vis the US dollar, which was
trade negotiations completely nullified the positive
pronounced in August and September. Overall, the
impact of government measures like rollback of the
fall in the INR during April-September 2019 was due
super-rich tax on FPIs, frontloading of capitalisation
to equity sell-offs by FPIs and strengthening of the
of public sector banks and deferment of a hike in
US dollar, triggered by rising risk aversion among
registration fees for automobiles. The BSE Sensex
investors on escalating US-China trade tensions and
surged nearly 5 per cent on September 20 spurred concerns over tepid global growth. While the INR
by the reduction in the corporate tax rate – the depreciated by 2.1 per cent vis-à-vis the US dollar
biggest rally in over a decade. Subsequently, the BSE on September 30, 2019 over end-March 2019, it
Sensex corrected on concerns about the health of the was modest in comparison with the depreciation of
domestic banking sector and political uncertainty in many of its EME peers such as the Malaysian ringgit,
the US. Overall, the BSE Sensex registered a gain of the South African rand, the Chinese yuan and the
3.6 per cent during September 2019. Brazilian real (Chart IV.12a).

In terms of the 36- and 6-currency nominal effective IV.1.6 Credit Market
exchange rate (NEER), the INR appreciated by 0.4 per In the credit market, offtake during the year
cent and 1.1 per cent, respectively, at end-September, (up to mid-September) has been muted; both,
2019 over March (average) 2019. Similarly, the INR, low momentum and unfavourable base effects
in terms of both 36- and 6-currency real effective dragged down non-food credit growth (Chart IV.13).
exchange rate (REER), appreciated during the same The seasonal decline in credit during Q1:2019-20
period (Table IV.2). was more pronounced than in the corresponding
The appreciation in REER of the INR between March quarter of the previous year. The offtake during Q2
and August 2019 was modest as compared with that (up to mid-September) has been subdued as compared
of the Taiwan dollar, the Russian ruble, the Philippine with the corresponding quarter of the previous two
peso, the Indonesian rupiah, the Turkish lira, and years.
the Thai baht (Chart IV.12b).
Table IV.2: Nominal and Real Effective Exchange

Rates – Trade-based Weights
(Base: 2004-05 = 100)
Index: Appreciation (+) /

End- Depreciation (-)
September (Per cent)
Item 2019 (P)
End- March 2019
September over
2019 over March 2018
March 2019
36-currency REER 116.7 1.3 -1.2

36-currency NEER 73.9 0.4 -1.7
6-currency REER 126.6 2,7 -0.9
6-currency NEER 64.6 1.1 -1.9
₹/US$ 70.69 -1.7 -6.4
P: Provisional.
Sources: RBI; and FBIL.

Of the incremental non-food credit flow during the

year (August 2019 over August 2018), personal loans
accounted for the largest share, followed by services
and industry (Chart IV.15b). Within personal loans,
credit offtake has been broadly concentrated in two
segments, viz., housing and credit card outstanding.
Within industry, credit growth to beverages and
tobacco, cement, engineering, vehicles, construction
and infrastructure (viz., power, telecommunications
and roads) accelerated.
Credit quality has deteriorated with both the

stressed assets ratio and the non-performing assets
(NPA) ratio increasing marginally in June 2019 after
four successive quarters of decline (Chart IV.16a).
Sector-wise analysis indicates that the NPA ratio
The slowdown in credit growth was led by public deteriorated for all sectors in June 2019, barring
sector banks and private sector banks, while credit industry (Chart IV.16b).
growth of foreign banks continued to be modest, Banks have reduced their investment in the non-
despite some uptick in the recent period (Chart IV.14). statutory liquidity ratio (SLR) portfolio by about
While credit growth to agriculture and personal loans ₹35,000 crore in 2019-20 (up to September 13). This
remained broadly unchanged in the last one year, credit is notwithstanding a marginal increase in exposure to
growth to industry moderated in the last four months CPs in contrast to a decline in H2:2018-19. With both
after accelerating continuously between August non-SLR investment and non-food credit undergoing
2018 and April 2019. Credit growth to services has a decline, adjusted non-food credit4 growth
decelerated sharply since January 2019 (Chart IV.15a). decelerated during the year so far (Chart IV.17).
4
Includes non-food credit extended by scheduled commercial banks and their investment in commercial paper as also bonds/shares/debentures issued by
private and public corporate sector.

With muted credit offtake and decline in non- decline in funding from banks and lower funding
SLR investments, banks have augmented their from non-bank sources. Among domestic non-bank
SLR portfolios despite the reduction in SLR by RBI. sources of funding, public issues of equity and private
Banks held excess SLR of 6.9 per cent of net demand placement increased significantly. Among foreign
and time liabilities (NDTL) on August 30, 2019 as sources, both external commercial borrowings and
foreign direct investment (FDI) registered sharp
compared with 6.3 per cent of NDTL at end-March
increases (Table IV.3). Notably, a new framework
2019 (Chart IV.18).
for external commercial borrowings was announced
Overall, financial flows to the commercial sector in January 2019 to improve the ease of doing
in 2019-20 so far (up to mid-September) have been business; subsequently, end-use provisions were also
lower than in the same period last year due to a rationalised in July 2019.

Table IV.3: Flow of Funds to the Commercial Sector

(Amount in ₹ crore)
Item April to mid-Sep

2018-19 2019-20
Amount Per cent Amount Per cent
to Total to Total
A. Flow from banks, i.e., Adjusted non-food credit (A1+A2) 1,85,083 25.1 -1,28,760 -141.5
A1. Non-food credit 1,65,187 22.4 -93,688 -103.0
A2. Non-SLR investment by scheduled commercial banks 19,896 2.7 -35,072 -38.5
B. Flow from non-banks (B1+B2) 5,51,004 74.9 2,19,755 241.5
B1. Domestic sources 4,44,696 60.4 13,562 14.9
1. Public issues by non-financial entities * 6,253 0.8 58,326 64.1
2. Gross private placement by non-financial entities * 47,379 6.4 62,495 68.7
3. Net issuance of CPs subscribed by non-banks 2,53,669 34.5 19,118 21.0
4. Net credit by housing finance companies $ 52,181 7.1 -6,003 -6.6
5. Total accommodation by 4 RBI regulated AIFIs * 40,032 5.4 -4,774 -5.2
6. NBFCs-ND-SI and deposit taking NBFCs (net of bank credit) $ 41,200 5.6 -1,25,600 -138.0
7. LIC’s net investment in corporate debt, infrastructure and social sector^ 3,982 0.5 10,000 11.0
B2. Foreign sources 1,06,308 14.4 2,06,193 226.6
1. External commercial borrowings / FCCB * -653 -0.1 54,073 59.4
2. Foreign direct investment to India ^ 1,06,961 14.5 1,52,119 167.2
C. Total flow from banks and non-banks (A+B) 7,36,087 100.0 90,995 100.0
$: Up to Jun ^: Up to Jul *: Up to Aug.

Sources: RBI; SEBI; BSE; NSE; NHB; LIC and merchant banks.
IV.2 Monetary Policy Transmission lending rate (WALR) on fresh rupee loans decreased
The response of deposit and lending rates of by only 29 bps (February-August 2019), the WALR
commercial banks to the cumulative reduction in the on outstanding rupee loans, in contrast, increased
policy repo rate by 110 bps during the easing cycle of by 7 bps over the same period. The inadequate
monetary policy starting from February 2019 has been transmission essentially reflects slow adjustment in
muted so far (Table IV.4). While the weighted average bank term deposit rates. This, in turn, reflects the
Table IV.4: Transmission to Deposit and Lending Rates

(Basis points)
Period Repo Rate Term Deposit Rates Lending Rates
Median Term WADTDR 1-year Median WALR - WALR - Fresh

Deposit Rate MCLR Outstanding Rupee Loans
Rupee Loans
Feb-Mar 2019 -25 -1 -2 -5 -3 -24

Apr-May 2019 -25 -6 0 0 7 13
Jun-Jul 2019 -25 -4 -4 -15 2 -9
Aug-Sep 2019* -35 -15 2 -15 1 -9
Feb-Sep 2019* -110 -26 -4 -35 7 -29
*: Latest data on WALR and WADTDR pertains to August 2019.

WADTDR: Weighted Average Domestic Term Deposit Rate. WALR: Weighted Average Lending Rate.
MCLR: Marginal Cost of Funds based Lending Rate.
Source: RBI.

long maturity profile of bank deposits at fixed interest transmission of policy rate to bond markets as against
rates. muted transmission to credit markets (Chart IV.22).
The WALR on fresh rupee loans declined during One of the important factors impeding monetary
February-August 2019 across bank groups, with the transmission is administered interest rates on small
largest decline observed in foreign banks and the least saving schemes set by the Government of India.
in public sector banks (Chart IV.19). These administered interest rates are linked to
market interest rates on G-secs with a lag and are
As the lending activity of public sector banks was
fixed on a quarterly basis at a spread ranging from
constrained by higher NPAs and lower capital
adequacy vis-à-vis private sector banks, the share of
fresh rupee loans of private sector banks overtook
that of PSBs in August 2019 (Chart IV.20).
Actual lending rates comprise marginal cost of funds
based lending rate (MCLR) and a spread. Banks
charged the lowest spread (WALR on outstanding
rupee loans over 1-year MCLR) on housing loans
during August 2019 reflecting (i) lower probability
of default; (ii) availability of good collateral; and (iii)
competition from NBFCs (Chart IV.21). At the other
end of the spectrum, the spread charged on ‘other
personal loans’ was the highest.
The spread between MCLR/WALR on fresh rupee
loans/outstanding rupee loans and G-sec yields has
risen sharply through 2019, reflecting complete

of interest on all small savings schemes (except

savings deposit) were reduced by 10 bps. Even after
the reduction, however, the small saving rates of
various schemes continued to be higher by 18-62 bps
in Q2:2019-20 than the formula-based interest rates.
With the Government deciding to keep the interest
rates on small savings unchanged for Q3:2019-20
notwithstanding a decline in G-sec yields in the
reference period (June-August 2019), the wedge
between the current small saving rates on various
schemes and the formula-based rates for Q3:2019-20
has widened further to 70-110 bps (Table IV.5).
The MCLR system of pricing loans lacks transparency
as it is internal to each bank and borrowers have no
way of ascertaining as to how it has been arrived at.
While it may not matter for new borrowers as they
0-100 bps over and above G-sec rate of comparable are able to compare overall lending rates across banks
maturities. Interest rates on small saving schemes and take a decision in their best interest, it impacts
were revised on June 28, 2019 for Q2: 2019-20, which existing borrowers as they cannot easily ascertain the
came into effect from July 1, 2019 whereby the rates factors that lead to the changes in MCLR. The MCLR
Table IV.5: Interest Rates on Small Savings Instruments – Q3:2019-20

Small Savings Scheme Maturity Spread Average G-sec Formula-based Rate Government Difference
(Years) (Percentage Yield (Per cent) of Interest (Per Announced (Basis points)
point)$ of Corresponding cent) (applicable Rate of Interest
Maturity (June 2019 for October to (Per cent) in
to August 2019) December 2019) Q3
(1) (2) (3) (4) (5) = (3) + (4) (6) (7) = (6)-(5)
Savings Deposit - 4.00 -
Public Provident Fund 15 0.25 6.81 7.06 7.90 84
Time Deposits
1 Year 1 0 5.85 5.85 6.90 105
2 Year 2 0 6.01 6.01 6.90 89
3 Year 3 0 6.18 6.18 6.90 72
5 Year 5 0.25 6.50 6.75 7.70 95
Post Office Recurring Deposit 5 0 6.50 6.50 7.20 70
Account
Post Office Monthly Income Scheme 5 0.25 6.47 6.72 7.60 88
Kisan Vikas Patra 113 Months 0 6.81 6.81 7.60 79
NSC VIII issue 5 0.25 6.66 6.91 7.90 99
Senior Citizens Savings Scheme 5 1.00 6.50 7.50 8.60 110
Sukanya Samriddhi Account Scheme 21 0.75 6.81 7.56 8.40 84
$: Spreads for fixing small saving rates as per Government of India Press Release of February 16, 2016.
Note: Compounding frequency varies across instruments.
Sources: Government of India; and RBI staff estimates.

system also did not deliver effective transmission as through reverse repos of maturity ranging from
banks were slow to adjust their deposit interest rates overnight to 63 days. In addition, liquidity aggregating
which, in turn, had a bearing on their lending rates. ₹47,128 crore was injected through variable rate
To address these concerns, the Reserve Bank, in repos of maturity ranging from 1 to 3 days. Four open
pursuance of the recommendations of an Internal market operation (OMO) purchase auctions and one
Study Group (Chairman: Dr. Janak Raj), mandated US$ 5 billion buy/sell swap auction was conducted
that all scheduled commercial banks (excluding by the RBI during H1:2019-20. Furthermore, the SLR
regional rural banks) should link all new floating was cumulatively reduced by 50 bps during H1 – 25
rate personal or retail loans and floating rate loans to bps each effective April 13 and July 6, respectively,
Micro and Small Enterprises (MSEs) to the policy repo – to 18.75 per cent of NDTL of banks, in accordance
rate or 3-month T-bill rate or 6-month T-bill rate or with the roadmap announced in December 2018 with
any other benchmark market interest rate published a view to enabling banks to raise structural liquidity.
by Financial Benchmarks India Private Ltd. (FBIL),
Drivers and Management of Liquidity
effective October 1, 2019. Banks are free to choose
the spread over the benchmark rate, subject to the RBI’s forex operations including US$ 5 billion buy/
condition that the credit risk premium may undergo sell swap auction and net OMO purchases were the
change only when the borrower’s credit assessment major drivers augmenting liquidity in H1:2019-20,
undergoes a substantial change, as agreed upon in the which was absorbed through operations under the
loan contract. External benchmarks are transparent liquidity adjustment facility (LAF) by the RBI. This
as they are available in the public domain and hence contrasts with H2:2018-19 when a large expansion in
easily accessible to the borrowers. The external currency in circulation (CiC) resulted in a leakage of
benchmark framework will improve transmission as liquidity from the banking system, which had to be
(i) the lending rates will be referenced to one of the replenished through large scale open market purchase
prescribed benchmark rates for new borrowers; and operations and liquidity injections under the LAF
(ii) banks would need to reset the benchmark rate at (Chart IV.23).
least once in three months for existing borrowers.
IV.3 Liquidity Conditions and the Operating

Procedure of Monetary Policy
The RBI Act 1934 amended in 2016 requires the
RBI to place the operating procedure relating to the
implementation of monetary policy and changes
thereto from time to time, if any, in the public
domain. During H1:2019-20, liquidity management
operations by the RBI were conducted within the
broad framework discussed in the Monetary Policy
Reports of October 2018 and April 2019. In addition
to regular operations during H1:2019-20, the RBI
resorted to fine-tuning variable rate repo and reverse
repo auctions. Liquidity amounting to ₹5,09,585 crore
was injected through the regular 14-day repos, while
liquidity amounting to ₹93,39,315 crore was absorbed

During H1:2019-20, the increase in CiC at ₹49,378 spending after government formation at the Centre,
crore (2.3 per cent) was muted in comparison with net forex purchases by the RBI and return of currency
the significantly higher increase of ₹95,896 crore (5.2 to the banking system post-elections. The RBI also
per cent) in the corresponding period of 2018-19. As conducted two OMO purchase auctions amounting
a result, growth in CiC (y-o-y) was consistently lower to ₹27,500 crore. Consequently, total injection of
than in the previous year (Chart IV.24). durable liquidity in Q1:2019-20 – through both
OMOs5 and US$/INR swap auction – amounted to
In April and May, liquidity conditions were in deficit
₹87,414 crore (Chart IV.25). The RBI absorbed surplus
due to restrained government spending and high
liquidity of ₹51,710 crore on a daily net average basis
demand for cash. The unwinding of GoI cash balances
under the LAF in June.
– a regular feature every year in April – was much
lower in the current year due to the imposition of the Surplus liquidity conditions persisted in July on
account of (i) return of currency to the banking
model code of conduct during elections restricting
system; and (ii) the Reserve Bank’s net forex
government spending. Combined with rising
purchase operations. Although liquidity continued to
currency demand, this caused liquidity tightness.
be in surplus in August, its drivers were distinctly
Consequently, the RBI conducted a US$/INR buy/
different. First, currency expansion picked up,
sell swap auction of US$ 5 billion (₹34,874 crore) for
draining systemic liquidity. Second, increasing geo-
a tenor of 3 years in April and two OMO purchase
political uncertainties in EMEs from political unrest
auctions in May amounting to ₹25,000 crore to inject
in Hong Kong and meltdown of financial markets in
durable liquidity into the system. It also injected
Argentina resulted in capital outflows necessitating
liquidity of ₹51,403 crore on a daily net average basis
forex market (sales) intervention by the RBI. These
under the LAF during these two months.
pressures were, however, more than offset by a
The situation changed in June when liquidity 5
OMOs include both purchases through auctions as well as transactions
conditions turned to surplus due to increased on the negotiated dealing system – order matching (NDS-OM) platform.

large drawdown of GoI balances, with the Central frictional liquidity movements. With the Reserve
Government resorting to ways and means advances Bank injecting durable liquidity through OMOs and
(WMA) for a major part of the month. In September, US$/INR buy/sell swap auction, net LAF positions
the surplus moderated with the build-up of large mirrored movements in government cash balances
government cash balances, particularly with the (Chart IV.27). The temporary mismatches between
receipt of advance taxes after September 15 (Chart receipts and payments of the government during
IV.26). Nevertheless, absorption of liquidity on a daily H1:2019-20 were partly met through recourse to
net average basis under the LAF soared to ₹1,31,370 cash management bills (CMBs) on two occasions
crore during Q2:2019-20 in contrast to a net injection of maturity ranging 10-33 days aggregating ₹50,000
of ₹17,409 crore in Q1. Simultaneously, transient crore.
liquidity needs were met through variable rate repos Fine-tuning operations through variable rate
of smaller tenors (1-3 days) in addition to the regular
auctions continued to be the key feature of
14-day term repos.
liquidity management during H1:2019-20. Liquidity
To sum up, the RBI’s forex operations and currency injections were made through repo auctions of
expansion were the prime drivers of durable maturities ranging from overnight to 14 days, while
liquidity in the banking system in H1:2019-20, reverse repos ranging from overnight to 7 days were
while government spending was the key driver of frequently used for absorbing liquidity (Table IV.6).
Table IV.6: Fine-tuning Operations through Variable Rate Auctions in H1:2019-20

Repo (maturity in days) Reverse Repo (maturity in days)
Operation
1 2 3 14 *
1 2 3 4 7 14 63
Frequency 1 1 1 52 100 5 27 4 33 1 1
(number of times)
Average volume 8,825 25,003 13,300 5,09,585 65,62,076 3,65,300 16,88,773 2,90,358 4,31,458 550 800
(₹ crore)
*: Regular 14-day variable rate repo operations
Source: RBI

Operating Target and Policy Rate

During H1, the WACR – the operating target of
monetary policy – generally traded below the repo
rate during May-September (Chart IV.28).
The objective of monetary policy is to keep the WACR

aligned to the policy repo rate and contain volatility
caused by exogeneous shocks within the interest rate
corridor defined by the lower (reverse repo rate) and
the upper (marginal standing facility rate) bounds.
There are, however, instances when the WACR
breached the corridor on account of: (i) uncertainty
about liquidity conditions; (ii) market microstructure
issues such as quarter-end or year-end liquidity
tightness (due to advance tax payments or window
dressing of balance sheet); (iii) structural changes in
the monetary policy implementation framework (for and (iv) banks’ expectations of future interest rates.
instance, making the policy corridor non-symmetric In this context, an empirical exercise identifies the
by raising the MSF rate 300 bps above the policy repo factors contributing to the occurrence of such episodes
rate in the aftermath of the taper tantrum episode); (Box IV.1).
Box IV.1: WACR Breaching the Policy Corridor: Causes and Determinants
Determinants of the spread (WACR over the microstructure variables (Table IV.1.1). Liquidity
policy repo rate) include market expectations, conditions have been defined as the net LAF
risk measures, liquidity conditions, and market position on any day as a proportion of the average
Table IV.1.1: Description of Variables

Variable Measured by Expected
impact6
Lagged spread First lag of spread (where spread is defined as weighted average call money market rate minus increase
repo rate)
Within period expectation 14 day Mumbai Inter-Bank Outright Rate (MIBOR) rate minus repo rate increase
Liquidity conditions Net LAF position/ average daily cash reserve requirement increase
Interest rate uncertainty Uncertainty about interest rate at 2 week horizon: GARCH(1,1) conditional volatility of 14 day increase
MIBOR rate
Liquidity uncertainty GARCH(1,1) conditional volatility of reserve fulfilment increase
Liquidity distribution Ratio of the volume in call money to total volume in overnight market increase
Corridor width dummy Corridor width as a dummy variable – it takes the value of 1 (if corridor width ≤ 100 bps) or 0 increase
(if corridor width > 100 bps)
Quarterly dummy Quarter-end phenomenon – value 1 for quarter-end and 0 otherwise increase
(Contd.)
6
The expected impact is in terms of the increase (decrease) in the odds ratio. The odds ratio is defined as p/(1-p), where p is the probability of the WACR
breaching the policy corridor.

daily CRR requirement. An increase (decline) in this where p indicates the probability of the call money
ratio would signify tightening (easing) of liquidity rate breaching the interest rate corridor. L is the logit
conditions leading to an increase (reduction) in the function and Xs refers to the independent variables.
spread under deficit liquidity conditions. Skewed The model is estimated based on daily data from
distribution of central bank’s liquidity among banks May 2011 to June 2019 covering 1960 observations
may impact the WACR spread adversely, i.e., greater (Table IV.1.2).
heterogeneity in distribution of liquidity (a few
participants cornering a large part of central bank The results suggest that an increase in skewness
liquidity) is likely to increase the demand for funds of liquidity distribution will increase the odds of
in the call money market and increase the spread the call rate breaching the interest rate corridor.
(Linzert and Schmidt, 2008; Kumar et al, 2017). This Similarly, an increase in liquidity conditions (more
variable has been approximated by the share of call injection by the RBI relative to the CRR requirement
market transactions in the total overnight market of banks) and an increase in interest rate uncertainty
volume. also increases the odds of the call rate lying outside
In addition to the above, two dummies are also the interest rate corridor.
used for the empirical exercise keeping in view Table IV.1.2: Logit Model – Results
the idiosyncratic factors witnessed during the
Variables Odds Ratio
sample period. First, a dummy for changes in the
1 2
liquidity management implementation framework
Lagged spread 1.002
is introduced for the period when the MSF rate was (0.587)
raised by 300 bps above the repo rate, as part of the Within period expectation 1.001*
policy response to domestic financial market turmoil (0.093)
Liquidity uncertainty 1.01
in the aftermath of the taper tantrum. Accordingly,
(0.856)
a value of 1 is taken for each day from July 17 to Liquidity distribution 1.05***
October 28, 2013 representing the post taper tantrum (0.000)
period and 0 otherwise. Second, a value of 1 for the Interest rate uncertainty 1.01***
(0.005)
period November 9, 2016 to January 31, 2017 and 0 Liquidity conditions 1.001**
otherwise is considered for the post-demonetisation (0.042)
period when the return of currency to the banking Quarterly dummy 3.25**
(0.022)
system resulted in large surplus liquidity with the
Post taper tantrum dummy 5.10**
WACR breaching the lower bound of the corridor, (0.050)
i.e., dropping below the reverse repo rate. Corridor width dummy 4.39***
(0.000)
Following an empirical strategy used in the literature Demonetization dummy 0.301
on regime shifts in capital flows (Forbes and Warnock, (0.109)
Constant 0.01***
2012), a logistic regression analysis (binary logit
(0.000)
model) was undertaken to estimate the probability Diagnostic Checks
of the call rate breaching the interest rate corridor LR chi test
2
112.3 (0.00)
(Prabu and Bhattacharyya, 2019). McFadden’s R 2
0.140
The following logit model was used: No. of Observations 1960

*** p<0.01, ** p<0.05, * p<0.1.
L = ln = β0+ β1 X1+ ……+ βk Xk + ε
Note : p-values are in parentheses.
(Contd.)

The quarterly dummy indicates that the odds of uncertainty about interest rates and foster stability
having the call rate lying beyond the corridor at by anchoring market expectations. Finally, liquidity
quarter-end ceteris paribus are 3.25 times as large forecasting needs to be prescient, particulary in
as the odds on non-quarter-end days. In a similar a narrow interest rate corridor regime, as large
fashion, the post taper tantrum dummy indicates forecast errors enhance the probability of the call
that the odds of having the call rate breaching the rate breaching the interest rate corridor in either
interest rate corridor on days of turmoil post taper direction.
tantrum were 5.1 times as large as against those days
not affected by financial market turbulence. Finally, References:
the corridor width dummy (corridor width ≤ 100
Forbes, K, J. and F.E, Warnock (2012), “Capital Flow
basis point is 1, 0 otherwise) indicates that the odds
Waves: Surges, Stops, Flight, and Retrenchment”,
of the call rate exceeding the interest rate corridor
Journal of International Economics, Vol 88(2), 235-
when the corridor width is lower than 100 bps is
4.39 times as large as the odds when the corridor 251.
width is higher than 100 bps. Linzert, T., and S. Schmidt (2011), “What Explains
From a policy perspective, the empirical exercise the Spread between the Euro Overnight Rate and the
provides useful insights for the liquidity management ECB’s Policy Rate?”, International Journal of Finance
operations of the central bank. As the findings & Economics, Vol 16(3).
suggest, skewness in liquidity distribution may Kumar, S., Prakash, A., and K. M. Kushawaha, (2017),
cause the WACR to deviate from the corridor; hence
“What Explains Call Money Rate Spread in India?”,
liquidity management operations and practices
RBI Working Paper Series, WPS (DEPR): 07/2017.
should endeavour to reduce liquidity concentration
among a few market players. Similarly, forward Prabu, E., and I. Bhattacharyya (2019), "Regime-
guidance through better communication on the Dependent Determinants of the Interbank Call Rate
evolving liquidity conditions can reduce market vis-à-vis the Policy Corridor”, RBI (Mimeo).
The WACR remained 6 bps above the policy repo rate

(on an average) in April and below the policy repo
rate by an identical margin in May. In June, however,
it remained closely aligned with the policy repo rate
(Chart IV.29). Subsequently, the WACR traded below
the policy repo rate (on an average) by 14 bps in July,
8 bps in August and 6 bps in September. Overall, the
WACR traded below the policy repo rate by 5 bps in
H1:2019-20 as compared with 6 bps in H2:2018-19.
IV.4 Conclusion
Domestic financial markets remained vulnerable to
global headwinds and geo-political uncertainties.
After post-elections exuberance, equity markets
turned risk averse reacting to global developments
and slowdown in economic activity. Capital flows

turned volatile in August, exerting depreciation consistent with the stated policy objective of aligning
pressures on currencies. By contrast, the bond market the WACR with the policy repo rate and ensuring that
rallied significantly, despite some correction in the durable liquidity needs of the economy are adequately
recent period. Credit growth, however, has slowed met, consistent with the stance of monetary policy.
down, reflecting subdued economic prospects. Going Ensuring faster monetary transmission to banks’
forward, liquidity conditions would be managed lending rates remains a key priority.

V. External Environment continue in Q3, as industrial production remains

subdued and exports continue to decline. The
Global economic activity has remained sluggish as Institute of Supply Management’s manufacturing
major advanced economies (AEs) and emerging index declined further into the contraction zone in
market economies (EMEs) slowed down in Q2:2019. September marking its lowest reading in a decade.
Mounting trade and geo-political uncertainties Nonetheless, strong consumer spending, as reflected
continue to cloud the near-term outlook. Monetary in rising retail sales, is expected to moderate the pace
policy has been easing across the world to support growth of slowdown to some extent.
concerns as inflation remains benign. Financial Euro area GDP growth slowed down in Q2:2019 as
markets remained volatile on still unfolding sequence its major constituent economies lost steam amidst
of US tariff actions and lingering uncertainty lingering uncertainties around Brexit and trade
surrounding Brexit. tensions. The German economy contracted in Q2 with
a struggling auto industry amidst falling exports; it
Since the Monetary Policy Report (MPR) of April
entered Q3 on a weak note as the manufacturing PMI
2019, global economic activity has weakened and
in September remained in contraction zone, marking
the near-term outlook remains clouded by trade and
geo-political uncertainties. Most major AEs and EMEs Table V.1: Real GDP Growth (q-o-q, annualised)
slowed down in Q2:2019. Crude oil prices remained (Per cent)
volatile on shifting demand-supply balances, most Country Q2- Q3- Q4- Q1- Q2- 2019 2020
2018 2018 2018 2019 2019 (P) (P)
recently caused by supply disruptions in Saudi
Advanced Economies
Arabia – the second largest oil exporter – estimated
Canada 2.5 2.1 0.3 0.5 3.7 1.8 1.7
to be of the order of around 5 per cent of global oil
Euro area 1.6 0.8 1.2 1.6 0.8 1.6 1.5
supply. Other global commodity prices remained Japan 1.9 -1.9 1.8 2.2 1.3 0.2 1.4
soft on subdued global demand. Central banks across South Korea 2.4 2.0 3.6 -1.6 4.0 2.6 2.8
the world eased monetary policy to support growth UK 2.0 2.4 1.2 2.4 -0.8 1.2 1.6
concerns as inflation remains benign. The calm US 3.5 2.9 1.1 3.1 2.0 2.3 1.9
that characterised global financial markets in the Emerging Market Economies
beginning of 2019 has been dispelled since May, with Brazil -0.4 2.0 0.4 -0.4 1.6 1.3 2.5
a combination of trade and geo-political tensions China 6.8 6.4 6.0 5.6 6.4 6.1 5.9
and the worsening global growth outlook imparting Malaysia 2.4 6.0 5.2 4.4 4.0 4.6 4.8
heightened volatility. Mexico -0.8 2.0 0.3 -1.0 0.1 1.3 1.6
Russia* 2.2 2.2 2.7 0.5 0.9 2.0 1.0

V.1 Global Economic Conditions
South Africa -0.5 2.6 1.4 -3.1 3.1 1.0 0.3
Economic activity has been losing pace across major Thailand 4.3 -0.9 3.6 4.1 2.4 3.9 3.7
AEs and EMEs. In the US, real GDP growth (q-o-q, Memo: 2018 2019 2020
(E) (P) (P)
annualised) decelerated in Q2:2019 to 2.0 per
World Output 3.6 3.2 3.5
cent, after rebounding in Q1, on slumping exports
World Trade Volume 3.7 2.5 3.7
and weak business fixed investment (Table V.1).
E: Estimate P: Projection *: y-o-y growth
Incoming data suggest that the slowdown may Sources: Bloomberg; and International Monetary Fund (IMF).

the ninth consecutive month of decline in factory activity showed a slight uptick in Q2, incoming
activity. GDP growth in Italy stagnated in Q2 as data showed signs of weakness for Q3 as consumer
contraction in industry and agriculture activities was sentiment remained subdued, with industrial
offset by an uptick in the services sector, though its production and retail sales weakening since July.
high level of debt and ongoing political uncertainty Nonetheless, higher fiscal spending for national
are downside risks. development projects may support aggregate demand,
The Japanese economy grew at a slower pace in going ahead.
Q2 than in the preceding quarter as escalating US- The economies of Brazil and South Africa rebounded
China trade tensions and slackening global demand in Q2, after witnessing a sluggish start to the year.
prompted a sharp downward revision in business Economic recovery in Brazil was largely supported
spending. Combined with a scheduled sales tax hike, by strong fixed investment and construction
this has clouded the economic outlook for the rest activity in Q2. While improved sentiment amidst
of 2019. Nonetheless, fiscal stimulus and rushed accommodative monetary policy is expected to
purchases ahead of the sales tax hike are expected to sustain the expansion, risks from both domestic and
support the economy in Q3. external challenges may contain the momentum. In
Real GDP in the UK contracted in Q2 on the back South Africa, economic activity accelerated on robust
of declining manufacturing activity due to planned growth in mining and manufacturing, thus recouping
early shutdowns of car plants in April following output losses witnessed in Q1. The consumption-
Brexit uncertainty. Risks from a potential hard Brexit led economic recovery, however, is expected to be
deal and evolving global trading conditions cloud the gradual as the uncertain global outlook and debt-
near-term outlook. ridden domestic power utilities may continue to
weigh on the overall prospects of the economy.
Economic activity remained subdued in key EMEs,
held down by weakening global economic conditions. The Indonesian economy slowed down to 5.1 per
The Chinese economy decelerated in Q2 (y-o-y) to its cent (y-o-y) in each of the first two quarters of 2019,
weakest pace in nearly 27 years, weighed down by pulled down by subdued investment and declining
the adverse impact of the prolonged and unresolved exports, amidst global uncertainty. In Thailand, the
trade dispute with the US, and subdued global downturn that had started in Q1 continued in Q2
demand. Available high frequency indicators suggest (y-o-y), marking the slowest growth in nearly five
that the downtrend may continue, going forward. years. The struggling farm sector, slowing exports
Industrial production and retail sales have declined and the weakening tourism sector resulted in the
since July, while the manufacturing PMI remains slowdown. The Turkish economy registered positive
subdued amidst weak demand. While the overall risk growth in the first half of 2019, recovering from last
remains titled to the downside on rising internal and year’s recession caused by a currency crisis. The
external headwinds, policy stimuli on both the fiscal recovery was underpinned by the stimulus provided
and monetary fronts are expected to cushion the in Q1 through high government spending and credit
pace of the slowdown. expansion.
Among other BRICS economies, the Russian economy The global composite PMI fell in August, after
is struggling to regain momentum after undergoing registering a marginal uptick in July, as slowing global
a sharp deceleration in Q1. While economic trade weighed down on overall export growth (Chart

V.1a). Among the major OECD economies, composite air freight, electronic components and automobile
leading indicators (CLIs) point to a slowdown in production. Movement in other indicators such as
growth momentum across major AEs and EMEs the Baltic Dry Index also remained sluggish, though
(Chart V.1b). with some signs of revival (Chart V.2b).
The slowdown in global trade, which began in the V.2 Commodity Prices and Inflation
later half of 2018, has continued in 2019, with
Global commodity prices weakened as trade tensions
contribution from EMEs slipping into contraction in
intensified. The Bloomberg commodity price index
2019 (Chart V.2a). Forward looking indicators suggest
declined by 4.1 per cent between April and September
that world trade is likely to slow down further in
2019.
2019. The WTO’s Goods Trade Barometer1 remains
below trend, driven by sluggish performance in The food price index of the Food and Agriculture
all its constituent indices, especially international Organisation (FAO) increased by 1.4 per cent during
1
WTO has replaced World Trade Outlook Indicator (WTOI) with Goods Trade Barometer.

April-September 2019. Global food prices rose for iron ore and nickel by major exporters and have been
the fifth consecutive month in May, driven by high trading side-ways thereafter, as the market awaits
dairy and maize prices resulting from tighter export further developments on the trade front. Copper
supplies. They, however, slid marginally in June-July prices fell sharply on waning demand, triggered by
as dairy prices fell on weak demand. Global food trade uncertainties, with intermittent increases in
prices moderated further in August due to a sharp June on a mine strike in Chile and weak Chinese
decline in cereals and sugar prices. While cereal prices refined copper output. Gold prices remained elevated
fell on ample export supplies, weakening Brazilian on safe haven demand as global uncertainties
currency and prospects of larger shipments by increased (Chart V.4).
India and Mexico kept sugar prices low (Chart V.3a).
Inflation remained benign in major AEs and EMEs.
Movements in global food prices have implications
Among AEs, CPI inflation in the US remained tepid
for food price inflation in EMEs (Box V.1).
despite tight labour markets, as the sensitivity
The stand-off between the US and Iran and agreement
by key oil producers to extend supply cuts further by
nine months exerted upward pressures on oil prices
in early May. However, a decline in the expected
demand for oil amidst adequate supplies eased
market tightness and weighed on prices, before
witnessing the biggest one-day gain on September
16, 2019, caused by supply disruptions to the
world’s largest oil processing facility in Saudi Arabia.
However, it eased thereafter on expectations of
supply restoration (Chart V.3b).
Base metal prices, measured by the Bloomberg base
metal spot index, declined by 9.0 per cent between
April and September 2019 on increased pessimism
over the growth outlook and slowing global demand
on persistent trade tensions. However, they recovered
marginally in July on elevated supply concerns about

Box V.1: International Food Prices – Pass-through to EMEs

International food prices have been among the during the first episode but were lower than many
most significant sources of domestic food price other cereal products during the second episode.
variations in many EMEs, as the share of food in According to the Law of One Price (LOP)
household expenditure is relatively high in these (Ardeni, 1989; Barahona and Chulaphan, 2017),
countries. The World Bank’s food price index in efficient markets for a single homogenous
increased by 23.8 per cent in 2007, 33.5 per cent in commodity, assuming no transport costs or
2008 and by 22.5 per cent in 2011, with unexpected obstacles to trade, prices expressed in a common
spikes seen across all food groups. Although the currency are equated according to the following
magnitude of price increases in these episodes was equation:
almost the same, the affected commodities were Pd = ER*Pw …(1)
different (Chart V.1.1). While rice, wheat, oil and where ER is the exchange rate [unit(s) of domestic
cereal prices remained high during 2007-08, sugar currency per unit of foreign currency], Pw is the
prices remained low. Rice prices were the highest world (foreign) food price and Pd is the domestic

food price. The estimable version of equation (1)

Table V.1.1: Estimated World Food Price
can be modified as a weak LOP hypothesis which in
Pass-through Coefficients
natural logarithm form is as below:
Country Long-run Short-run
lnPd = α + βlnPw + γlnER + et …(2) Brazil 1.136*** 0.024*
Pw is implicitly assumed to be an exogenous China 0.179** 0.029*
variable, as EMEs are generally price takers and β India 0.038*** 0.054*
is the long-term price transmission elasticity in the Indonesia 0.355*** 0.082***

Thailand 0.933*** 0.040*
presence of a long-run relationship. The short-term
Turkey 0.055*** 0.130***
price elasticity can be estimated from the error
Note: ***, ** and * denote 1 per cent, 5 per cent and 10 per cent level
correction model (ECM) of the following form: of significance, respectively.
Source: RBI staff estimates.
…(3) All the transmission elasticities are positive and

different from zero and short-run elasticities are
Where Δ is the first difference operator, ECT is the
lower than the long-run elasticities, barring for
error correction term, φ and γ are the short-term
Turkey and India. The short-run price transmission
transmission elasticities and ρ is the persistence
elasticity for food price in India is 0.05, implying
parameter.
that if world food price increases by one per cent,
Against this backdrop, the pass-through of changes food CPI in India could increase by five basis points.
in world food prices to domestic food prices was
To summarise, volatile food prices pose a
examined for six EMEs, viz., Brazil, China, India,
significant policy challenge across the world and
Indonesia, Thailand and Turkey as these countries
have implications for domestic inflation in EMEs,
have a high share of food items in their consumer
especially those having high share of food imports.
price indices (Sahoo et al., 2019). Using monthly
data from January 2007 to July 2019, it was found References:
that each of the variables, viz., global food price Ardeni, P. G. (1989), “Does the Law of One Price
index, country-specific food price indices and Really Hold for Commodity Prices?”, American
exchange rates are integrated of order one, i.e., Journal of Agricultural Economics, 71(3), Vol. 71,
I(1). Therefore, the existence of a cointegrating no. 3, pp. 661-669.
relationship was examined through vector error
Barahona, J. F. and W. Chulaphan (2017), “Price
correction model (VECM). The lag length of each
Transmission between World Food Prices and
model was based on Akaike Information Criteria
Different Consumer Food Price Indices in Thailand”,
(AIC). The estimated VECM model for each country Kasetsart Journal of Social Sciences, Available
confirms that residuals are not serially correlated. online at: https://www.sciencedirect.com/science/
The estimated short-run and long-run transmission article/pii/S2452315117300206?via%3Dihub.
elasticities reveal that the magnitude of price Sahoo, S., S. Kumar and B. Gupta (2019),
transmission from world food prices to domestic “International Food Prices – Pass-through to EMEs”,
food prices differs across countries (Table V.1.1). Reserve Bank of India (Mimeo).

of inflation to levels of resource utilisation V.3 Monetary Policy Stance

remains low. However, it registered a modest uptick Monetary policy has become accommodative across
in July on recovering energy prices. While core major AEs and EMEs. The US Fed has reduced its
personal consumption expenditure (PCE) – the Fed’s policy rate twice since July 2019 on concerns over
preferred measure of inflation – has been picking lingering trade uncertainties and muted inflationary
up since June, it remains below the US Fed’s 2 per pressures (Chart V.6a). The European Central Bank
cent target. In the Euro area, inflationary pressures (ECB) reduced the interest rate on deposit facility
have been easing on soft energy costs and weakening deeper into negative territory, while approving
growth. In Japan, CPI inflation remained muted a fresh round of monetary stimulus in the form
amidst falling food, transport and communication of bond purchases of 20 billion euros per month,
prices (Chart V.5a). beginning from November 2019. Ebbing inflation,
Inflation has been easing in many EMEs. In Russia, waning business confidence and fears of Germany
inflation edged lower since Q2 as consumer demand sliding into recession prompted the ECB to unveil
remained weak, while easing supplies on a strong another round of quantitative easing. The ECB has
also indicated that rates will remain at present or
harvest and appreciating ruble have added to
lower levels until the inflation outlook converges to a
disinflationary conditions. In Brazil, CPI inflation has
level sufficiently close but below 2 per cent within its
been falling since April on the back of soft food and
projection horizon.
fuel prices; however, it picked up marginally in August
on rising housing and transport prices. In South Africa, The Bank of Japan (BoJ) continued with its ultra-loose
inflation eased in July, after remaining steady in Q2 monetary policy on mounting downside risks to the
on falling fuel prices. In August, however, it edged up economy and signalled a ramping up of stimulus if
on rising food and housing prices. Inflation in Turkey, growth momentum loses further. The UK and Canada
which has been ebbing since April, registered a sharp kept their policy rates unchanged, while South
drop in June, driven by a favourable base effect and Korea kept its policy rate unchanged in August, after
softening of food prices. In July, however, it showed reducing it by 25 bps in its July meeting on concerns
a slight uptick on high service prices resulting from over slowing growth.
increased municipal tariffs, before resuming its Central banks in EMEs have turned increasingly
downward path in August (Chart V.5b). dovish in sync with their AE counterparts on easing

inflation conditions and weakening economic other EMEs, Turkey slashed its policy rate by 425 bps
outlook. Among the BRICS, the People’s Bank of and 325 bps in July and September, respectively,
China (PBOC) continued with its loose monetary exceeding market expectations, as the improving
policy stance, while indicating potential policy inflation outlook provided more space for policy
adjustments, going forward, as the domestic situation easing. The Philippines reduced its policy rate for the
warrants. Moreover, with the aim of stimulating the third time in 2019 in its September meeting with a
economy via ample liquidity conditions, the PBOC view to reviving business investment and supporting
provided liquidity support to small and medium sized slowing economy. Mexico reduced its policy rate in
banks by increasing rediscount quota and standing September, making it the second consecutive cut
lending facility to RMB 200 billion and RMB 100 since August. Chile has reduced its policy rate twice
billion, respectively, in June. In order to support the since June. Indonesia reduced its policy rate by 25
development of the real economy and lower financing bps in its September meeting, making it the third
costs, the PBOC lowered the required reserve ratio consecutive cut in Q3:2019, for boosting economic
for financial institutions by 50 bps in September growth amidst low inflation (Chart V.6b).
2019 (excluding finance companies, financial leasing V.4 Global Financial Markets
companies and auto finance companies). In an effort to
Financial markets remained volatile as sentiment was
increase the support for micro and small businesses,
repeatedly impacted by the still unfolding sequence of
it has also decided to lower the required reserve ratio
US tariff actions and lingering uncertainty surrounding
by 50 bps each on October 15 and November 15, 2019
Brexit. Global equity markets witnessed sharp sell-
for rural commercial banks operating solely within
offs in May reversing the gains till April. However,
provincial administrative regions. Furthermore, it
markets recouped most of the losses in June-July as
reduced its loan prime rate for one year maturity by
sentiment was buoyed by dovish guidance by major
5 bps in its September meeting.
central banks and renewed hopes of trade truce,
Brazil cut its policy rate twice since July, attributing it before declining again in August as unresolved and
to moderating inflationary pressures and weakening intensifying trade dispute triggered bearish sentiment.
economic activity. Russia reduced its policy rate thrice In September, positive signals on trade negotiations
in 2019 on falling inflation and weak demand. South buoyed investors’ risk appetite. Bond yields eased
Africa held its policy rate in September, while reducing across major economies on safe haven demand, while
it in July amidst ebbing inflation expectations. Among currency markets remained volatile.

Among AEs, US equities gained in June-July, after Weak South Korean equities following trade conflicts
correcting in May, driven by resilient corporate with Japan, political unrest in Hong Kong, crash
earnings data for Q1:2019 and rising expectations in Argentina’s financial markets and escalating
of monetary policy easing by the Fed in the coming trade tensions pulled down EME stocks further in
months. In August, while increasing risk-off sentiment August. However, some of the losses were recovered
amidst intensifying trade tensions and growth worries subsequently as market sentiments were boosted
led to large sell-offs, positive developments on the by postponement of tariff imposition and signals of
trade front revived market sentiment in September, stimulus for the Chinese economy (Chart V.7).
as a result of which equity markets recovered most of
Bond yields have eased across major AEs and EMEs
its losses suffered in August. In the Euro area, equity
as investors looked for safe havens on waning risk
markets tumbled in May in response to weak German
appetite. US bond yields softened in May, after
data. However, they remained supported in June-July
picking up in April on better GDP data for Q1. They
on expectations of monetary policy accommodation
have declined sharply since then, even falling below 2
by the ECB and positive developments in earning
expectations for non-financial corporations. per cent in August amidst heightened trade tensions
Nonetheless, markets ended August on a soft note as and dovish stance of the US Fed. A sharp fall in
growth worries resurfaced on weak German data and long-term yields has led to a negative yield spread
political turmoil in Italy. Japanese equity markets between 10-year and 3-month Treasury securities, as
also firmed up in June-July after correcting in May. addressed in Box I.1 in chapter I.
Markets maintained an uptrend in July as trade In the Euro area, bond yields plunged into negative
concerns receded, though they plunged in the middle territory in most of its constituent economies as
of the month on appreciation of the Yen and concerns expectations of dovish monetary policy stance by the
over deteriorating performance of some export- ECB gained traction, amidst a weakening economic
oriented companies. Equity markets in AEs entered outlook. Lacklustre data for Germany and political
September on a positive note as global investors’ uncertainties in Italy added further downward
sentiment was lifted on reduced tensions in Hong pressure. In Japan, bond yields continued to trade in
Kong and renewed hopes of trade negotiations. negative territory on subdued risk appetite. In most
Stock markets in EMEs fell as the strong US dollar EMEs, bond yields have been falling, with central
acted as a headwind leading to capital outflows. banks becoming highly accommodative as benign

inflation has freed up policy space to boost slackening dollar and mounting spillover risks arising from trade
economic growth (Chart V.8a). tensions. Between April and September 2019, the
In currency markets, the US dollar weakened against MSCI Emerging Market Currency Index declined by
major currencies in June on dovish guidance by the 2.0 per cent (Chart V.8b).
US Fed but it has rebounded since July, recouping V.5 Conclusion
most of its losses made in Q1. Safe haven demand
In sum, global economic activity continues to
amidst weaker growth prospects in other AEs
lose momentum as prolonged uncertainties
also strengthened the US dollar. The euro lost
ground against the US dollar as the economy lost relating to geo-political developments dampened
momentum, while higher probability of the ECB to economic sentiment. With inflationary pressures
stimulate the economy pulled the currency further remaining benign and market sentiment remaining
down. The Japanese yen outperformed most of the fragile, risks to the global outlook remain on the
major currencies as trade war induced uncertainties, downside. However, monetary and fiscal stimuli
coupled with worsening global growth conditions, across the globe may help in containing the pace
played up investors’ risk-off sentiments. Most of the of slowdown and putting the global economy on a
EME currencies suffered losses against the strong US recovery path.

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Monetary policy report * OCTOBER 2019

RBI Bulletin October 2019 9

activity amidst deteriorating global growth and

10 RBI Bulletin October 2019

RBI Bulletin October 2019 11

12 RBI Bulletin October 2019

RBI Bulletin October 2019 13

7.2 per cent in Q4:2019-20 and then moderate to 7.0

14 RBI Bulletin October 2019

banks to their lending rates impart an upward bias to

RBI Bulletin October 2019 15

Box I.1: Does Yield Spread Predict Output Growth?

16 RBI Bulletin October 2019

Table I.1.1: Correlation between GDP Growth and Yield Spreads

RBI Bulletin October 2019 17

18 RBI Bulletin October 2019

(iv) Food Prices 2019-20 and the early months of 2020-21. Volatility

RBI Bulletin October 2019 19

20 RBI Bulletin October 2019

underwent substantial correction in respect of both

RBI Bulletin October 2019 21

22 RBI Bulletin October 2019

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24 RBI Bulletin October 2019

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26 RBI Bulletin October 2019

After registering price increases between March-

RBI Bulletin October 2019 27

Box: II.1: Time-varying Estimates of Spillovers from Food Inflation to Inflation

28 RBI Bulletin October 2019

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30 RBI Bulletin October 2019

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32 RBI Bulletin October 2019

Table III.1: Real GDP Growth (Per cent)

RBI Bulletin October 2019 33

34 RBI Bulletin October 2019

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Box III.1: Slowdown in the Automobile Sector

36 RBI Bulletin October 2019

RBI Bulletin October 2019 37

estimates of the Ministry of Agriculture – only 0.8 per

38 RBI Bulletin October 2019

Table III.2: Key Fiscal Indicators – Central

RBI Bulletin October 2019 39

40 RBI Bulletin October 2019

RBI Bulletin October 2019 41

Table III.3: Government Market Borrowings

2017-18 2018-19 2019-20 (September 30, 2019)

42 RBI Bulletin October 2019

RBI Bulletin October 2019 43

III.2 Aggregate Supply

On the supply side, the gross value added (GVA)

The deceleration in GVA growth (y-o-y) was caused

Table III.4: Sector-wise Growth in GVA

Sector 2017-18 2018-19 Weighted 2017-18 (FRE) 2018-19 2019-

FRE: First Revised Estimates; PE: Provisional Estimates.

44 RBI Bulletin October 2019

In 2019, the south-west monsoon started with a

is the long-term price transmission elasticity in the Indonesia 0.355* 0.082*