Inflation, Budget and its implications: RBI's two guiding forces on rates

Madan Sabnavis, chief economist, CARE Ratings (Photo: PHOTO CREDIT: Kamlesh Pednekar)
The guiding forces for Friday’s monetary policy committee (MPC) decision were twofold. The first was inflation, which has been trending downwards and likely to also be lower in January. Was this sufficient a trigger for lowering rates considering that the base effect will get weaker in February and March?  The second was the Budget and its implications. The indication given was that government borrowing would be higher for fiscal 2020-21 (FY21), for which the Reserve Bank of India (RBI) has already provided the schedule for next two months. FY22 will also involve heavy borrowing by the centre and states, which would also have to be provided for. The G-Sec yield had moved up post announcement of the Budget with the 10-year paper being above 6 per cent.

Against this background, the MPC has chosen to maintain a status quo position both on rates and stance, which is comforting. The accommodative stance means that as of now chances of raising interest rates can be ruled out and gives comfort to the markets. This will still keep the market guessing of the next step in the April policy when the new financial year commences, where private sector demand for credit will also be buoyant. The tone, however, is that growth will still continue to be the primary driving factor in the coming year, even as the Committee keeps close watch on inflation.

The gross domestic forecast (GDP) forecast for next year is 10.5 per cent, which is within the range of the consensus forecasts with the government also looking at a number of 11 per cent. This is indicative of pick-up in bank credit, too, in the coming year. Interestingly, the inflation forecasts are pointing to a decline from 5.2 per cent in March 2021 quarter (Q4) to 5-5.2 per cent in H1-FY22 and 4.3 per cent in Q3. This hence supports the accommodative stance to be taken.

The other signals expected from the policy related to the rollback of measures announced during the pandemic. The two areas of interest are the cash reserve ratio (CRR) cut, which was to be till March 31, 2021 and the other to the series of liquidity enhancing measures which were very gradually rolled back in the last couple of policies, especially those on long-term refinancing option (LTRO) being redeemed earlier.

On liquidity, there is assurance that it will be provided in adequate quantities and that the market perception of a rollback was not founded on any strong basis. Therefore, we can expect further such action from RBI to also fully facilitate government borrowing in FY22. In fact, the RBI has stated that the CRR will be lowered in two phases on March 27 and May 22, which in effect, will open the doors for other liquidity enhancing measures by the RBI. This is something which the market will be watching for.

On the measures for the financial system extension of TLTRO to NBFC through the on-tap route is significant as this was a long-standing demand. NBFCs provide a very important last mile connectivity to the borrower. This will be useful for this segment and help in channeling of funds to the final beneficiaries. This is also a segment that required support given the developments in the last couple of years.

An interesting measure is to give retail access directly to the market. While it is quite unique the participation will depend on understanding of how these bonds work and also the ability to operate in the secondary market successfully. This has been a problem in the corporate bond market too, and hence the structures would be keenly awaited.

Quite clearly the tone has been set for the next year, which will be stable to a large extent, unless there is a serious economic shock.

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