The monetary policy committee (MPC) unanimously voted to leave repo rate unchanged at 4% and continue with accommodative stance of monetary policy as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Reverse repo was also unchanged at 3.35%.
Assessment:
In terms of assessment, the document noted the fragile state of global and local growth even as domestic agricultural prospects have strengthened owing to monsoon and area sown. However, consumer sentiment has turned more pessimistic and external demand is expected to remain anaemic. Real GDP growth in H1 FY21 and full FY21 is estimated to be in contraction.
Inflation pressures are evident across all sub-groups in CPI. However, household’s 1 year inflation expectations were lower than 3 month expectations in July 2020. Also, more favourable food inflation outlook may emerge from bumper Rabi harvest, supported by expanded market sales and public distribution offtake following high procurement. On the flip side, elevated fuel prices will add to cost push pressures. Overall, CPI is expected to remain elevated in Q2 FY21 and likely to ease in H2 FY21 aided by base effects. June release of headline CPI after a gap of 2 months and imputed prints for Apr-May have added uncertainty to the inflation outlook (for the purpose of monetary formulation and conduct, the MPC is of the view that CPI prints for April and May can be regarded as a break in the CPI series)
Guidance:
Importantly the guidance remains dovish, noting that “supporting the recovery of the economy assumes primacy in the conduct of monetary policy” and that “in pursuit of this objective, the stance of monetary policy remains accommodative as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy”. Space available to use monetary policy exists but it is important to use it judicially to maximise benefits for economic activity. At the same time the MPC remains conscious of medium-term inflation target and remains watchful for a durable reduction in inflation to use monetary policy space for growth revival.
Additional measures:
As is almost the convention now in these extra-ordinary times, there were a host of other measures announced aimed at easing financial conditions and improving credit flow:
- Rs. 10,000cr at repo rate to NABARD and NHB – 1) Rs. 5,000cr to NHB to support HFCs (after the Rs. 10,000cr already given), 2) Rs. 5,000cr to NABARD (after the Rs. 25,000cr already given) to refinance small NBFCs and MFIs
- To provide a window under the ‘prudential framework on resolution of stressed assets’ dated 07 June 2019 to enable lenders to implement a resolution plan for eligible corporate exposures (without change in ownership) and personal loans, while classifying such loans as standard and subject to specific conditions. Necessary safeguards are incorporated (prudent entry norms, defined boundary conditions, specific binding covenants, independent valuation and strict post-implementation performance monitoring). Framework not available for financial and government bodies. Theme is preservation of soundness of Indian banking sector; Expert committee headed by Shri. K.V. Kamath to recommend required financial parameters in resolution plans along with sectoral benchmarks and also validate process of resolution plans for accounts above a specific threshold
- Restructuring MSME debt (already in place if account was standard as on 01 Jan 20) so that stressed MSMEs can utilise this if account was standard as on 01 March 2020 but this will have to be implemented by 31 March 2021
- Maximum loan-to-value of loans sanctioned by banks against gold ornaments & jewellery for non-agricultural purposes, which is currently 75%, has been increased to 90%
- Banks investment in debt MFs and debt ETFs will be treated consistently with direct debt investments in terms of capital allocation (boost to corporate bond market)
- Review of priority sector guidelines and incentive-based framework is being put in place to address regional disparities (lower/higher weight for incremental priority sector credit in districts where credit flow is higher/lower and priority sector status for start-ups, etc.)
Takeaways:
Given the limited marginal utility of conventional easing, both to the system as well as to the bond market, we were largely agnostic to a rate cut going into this policy. Importantly, our view was basis the marginal utility argument and not basis the recent rise in CPI. One cannot simultaneously worry about the massive growth collapse and inflation, at least not in the conventional sense. Another way to think about this supply driven recent inflation is that it will very unlikely have material second round effects in the form of wages and product price push.
The risk if at all was that of a prolonged discussion on inflation in the MPC and the possible subsequent muddying of the forward guidance. It is no longer continued easing of policy rates that matters as much as the assurance that the stance on rates and liquidity remains accommodative, as well as the continued evaluation of non-conventional measures. In the event, the RBI / MPC delivered to the letter. Thus while the recent inflation spike was acknowledged, the fact of data inadequacy as well as the strong likelihood that the spike is temporary was also noted. Additionally, even as the primary mandate of the MPC was reiterated, so was the necessity that supporting growth is of paramount importance at the current juncture. Thus the market comes away with its expectations of future easing largely intact, even as some modest grumbling was duly registered in the form of a minor rise in yields today reflecting the lack of rate cut or other bond-supportive measures (some participants were hopeful for a held-to-maturity limit hike for banks).
Overall the policy today is a continued acknowledgment of the fact that the material role in the current context is of the RBI and not the MPC. The setting of the repo rate is irrelevant as the system now operates at reverse repo. The assurance of abundant additional liquidity and the execution of this promise rests with the RBI. Unconventional measures to ensure the financing of the higher public deficits happens without incremental tightening in financial conditions is also in the RBI’s domain. Finally, regulatory measures to facilitate flow of credit and preserve risk capital also are squarely with the RBI. In such a scenario while the increasing irrelevance of the MPC has to be acknowledged and potential risks associated with the same need to be considered down the line, the fact of this irrelevance cannot be used as a justification to withhold the most critical components of non-fiscal policy that exist in the armory today. It is comforting to see that the RBI shares this point of view.
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