High inflation amid muted GDP forecast could be a party pooper for markets

Topics RBI Policy | RBI | Inflation

Deepak Jasani - HDFC Securities
The Reserve Bank of India’s (RBI’s) fifth bi-monthly monetary policy announcement was majorly on expected lines as the markets were already factoring-in a status quo. That said, the policy statement looks a bit conservative with lower-than-expected upward revision in the gross domestic product (GDP) forecast and higher-than-expected inflation projection especially for H2FY22.

Furthermore, the RBI’s forecast of 5.2 per cent to 4.6 per cent inflation shows that the RBI expects reasonably high inflation well into the next fiscal year, which in my view, is rather cautious. For all we know, the inflation might begin subsiding post January 2021 once supply-side issues are addressed.

Therefore, given the RBI's projection, we may not see any further rate cut at least till mid-March 2021. It may also get postponed to next fiscal year.

On the liquidity front, the MPC also unanimously decided to continue with accommodative stance of the monetary, at least till the current financial year, and into next year to revive growth on a durable basis and mitigate the impact of Covid-19. In effect, the RBI has not withdrawn liquidity support from the markets which, although unexpected, bode well for the economy despite short-term rates being low.

Amid the expected policy outcome, the RBI has asked commercial banks to refrain from paying out dividends to shareholders for FY20. The decision makes sense as the outlook with respect to non-performing assets (NPAs) remains uncertain. In this situation, it is better to conserve banks’ capital.Therefore, shareholders won’t mind foregoing their dividends as long as the prices of the shares they hold remain largely intact.

Since the announcements are on the expected line, there aren't either positive or negative surprises for the markets. The euphoria in the banking space due to no withdrawal of liquidity may die out in a couple of days and bank stocks will go back to their original trajectory. The announcements will not impact the market trajectory in a big way.

That said, the bear camp, or the people who think markets are overvalued, have got more ammunition from the policy statement in terms of higher inflation projections and lower-than-expected GDP growth forecast. For them, predicting the topping out of markets has become easier, and these could eventually become a party pooper.

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