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    RBI Policy Review: Reasserting accommodative stance through non-interest rate tools

    Published on February 6, 2020

    In line with consensus and our expectations, the Reserve Bank of India’s Monetary Policy Committee maintained status quo in its 6th bi-monthly policy review. As such, the repo rate continues to remain at 5.15% (lowest since May-10). The second consecutive decision to leave rates unchanged was backed by a unanimous vote from all six MPC members. The MPC also decided to retain its ‘accommodative’ stance on monetary policy.

    Key forecasts

    Growth: The central bank continues to expect FY20 GDP growth at 5.0%, same as recently presented by the NSO (for details, see – FY20 GDP growth estimated at 11-year low, Jan 7, 2020). For FY21, it expects GDP growth to improve to 6.0%.

    • H2 FY20 growth is expected in the 4.9-5.5% range (unchanged vis-à-vis the previous projections made in Dec-19)
    • H1 FY21 growth is expected in the 5.5-6.0% range (revised lower from 5.9-6.3% projected in Dec-19)
    • Q3 FY21 growth is projected at 6.2%

    Inflation: The central bank raised its near term CPI inflation trajectory upwards.

    • Q4 FY20 inflation projection now stands at 6.5% (revised higher from 4.5% projection in Dec-19)
    • H1 FY21 inflation is expected in the 5.0-5.4% range (revised higher from 3.8-4.0% range projected in Dec-19)
    • Q3 FY21 CPI inflation has been introduced at 3.2%

    Rationale for forecasts

    • The moderate downward revision to H1 FY21 GDP growth forecast possibly incorporates (i) some spillover impact of lackluster momentum from H1 FY20, (ii) cut in government’s revenue expenditure (ex interest payments) by INR 628 bn as per the revised fiscal estimates for FY20 (for details, see –FY21 Union Budget: Execution holds the key, Feb 1, 2020), and (iii) temporary headwinds from the outbreak of coronavirus on tourist arrivals and external trade. However, the RBI expects a moderately strong revival in FY21 led by (i) Improved rabi sowing, recent shift in Terms of Trade in favor of farm sector, and higher budgetary allocation for the rural sector in FY21 should be supportive of rural demand, (ii) thawing of US-China trade relations should encourage exports, and (iii) gradual progress in the monetary transmission process should gradually start spurring consumption and investment demand.
    • The upward revision to near term CPI inflation trajectory highlights the incorporation of sharp unanticipated spike in onion price post the disruption tokharif sowing earlier. In addition, the revised estimates also seems to have factored in hardening of prices for milk and pulses, which the central bank believes could sustain. Further, the impact from the recent hike in telecom tariffs and the minor inflationary impact of FY21 Union Budget via increase in custom duties also appears to have come on board. While the RBI expects inflation to remain above the 4% target in H1 FY21, it expects it to fall below target in Q3 FY21 with output gap remaining negative and base effect turning supportive.

    Easing of regulatory set-up

    Even as the action on monetary policy was on expected lines, the RBI announced a host of measures on the regulatory front to support credit flow, sentiment, and overall growth environment.

    • Liquidity managementhas been fine tuned. Henceforth, the RBI will withdraw daily fixed rate repo and four 14-day term repos (conducted every fortnight currently). However, the central bank will ensure adequate provision/absorption of liquidity as warranted by underlying and evolving market conditions, unrestricted by quantitative ceilings, at or around the policy rate. A 14-day term repo/reverse repo operation at a variable rate will now act as the main liquidity management tool for managing frictional liquidity requirements. Similar to the ECB, the RBI will also provide durable liquidity via long term repo operations (LTROs) starting Feb 15, 2020 (1-3 year maturity with a cumulative size of INR 1 trillion).
    • In a bid toincentivize bank credit to specific sectors, banks will be allowed to deduct the equivalent of incremental credit disbursed by them as loans for automobiles, residential housing and MSMES, over and above the outstanding level of credit to these segments as at the end of Jan 31, 2020 from their NDTL for maintenance of CRR. This exemption will be available for incremental credit extended up to Jul 31, 2020.
    • External benchmarkingof fresh floating rate loans (currently applicable for micro and small enterprises) has now been extended to cover medium enterprises.
    • The RBI hasextended the regulatory forbearance for MSMEs. The one-time restructuring without asset classification downgrade provided earlier will now get extended to standard accounts of GST registered MSMEs that were in default as on Jan 1, 2020. The restructuring under the scheme has to be implemented latest by Dec 31, 2020.
    • The RBI will nowpermit extension of date of commencement of commercial operations of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another one year without downgrading the asset classification, in line with treatment accorded to other project loans for non-infrastructure sector.

    Our take

    The recent food price shock and uncovering of hidden inflation in certain category of services has led to the breach of RBI’s upper threshold of inflation targeting band (for details, see – CPI inflation ends 2019 with a shocker, Jan 13, 2020). While some of the recent drivers of inflation (like vegetables and fruits) are bound to reverse on account of delayed kharif arrival and expectation of a healthy rabi outturn, items like telecom tariffs and medicines could provide upside, especially to core inflation. Hence, we expect average CPI inflation to remain above 6% between Q4 FY20 and Q2 FY21, before cooling off to 3.0-3.5% range in H2 FY21. As such, we continue to expect an extension of pause on repo rate until H1 FY21Thereafter, with inflation slipping below 4% and output gap persisting in the negative territory, the MPC is likely to opt for a 25 bps rate cut in Oct-20 policy review.

    In the meanwhile, it is encouraging to see that the RBI has started to explore various options in its toolkit to support overall growth environment. The usage of Operation Twist since Dec-19 has had a salutary impact on long tenor yields. This got supplemented with further refinement in liquidity policy, time bound relaxation of regulatory forbearance, and use of macro-prudential incentive tools. This we believe will work in tandem with the fiscal policy to not only provide a safety net for select sectors, but also help in fostering a recovery in generalized economic activity.

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