RBI policy: Clearly more sanguine on growth, but cautious on inflation

Madan Sabnavis, chief economist, CARE Ratings (Photo: PHOTO CREDIT: Kamlesh Pednekar)
The RBI monetary policy action in the last couple of policies was quite predictable, as inflation has been high and the economy has moved from the ‘lockdown’ to ‘unlock’ phase. This, in a way, has made it easier to take a decision and hence the market should not really be surprised. However, the immediate reaction was a slight upward movement in the 10-years G-Sec.

The Reserve Bank of India (RBI) has been working on the liquidity side to guide interest rates, especially on bonds, as given the large volumes of borrowings by the government, interest rates should have increased. The combination of open market operations (OMOs), operation twist and targeted long-term refinance options (TLTROs) has helped immensely to achieve this objective. In fact, the announcements made in the last policy of allowing banks to reverse the LTROs was a way of drawing back on the quantitative easing (QE), which was brought about in a definite way since March when the lockdown was imposed. Hence, there has been a lot of discretion showed by the central bank, as there have been large investments made by banks in the overnight reverse-repo auctions.

The RBI, however, in its statement has indicated that there is still room for monetary policy support for growth, which is not yet broad-based, as per the latest information available. Hence, one may expect that the RBI can cut interest rates based on the inflation trajectory. That said, a lot will depend on how food inflation moves in the next few months. The expectation is that inflation will be above 5.5 per cent for the rests of the year with Q3FY21 at 6.8 per cent and at Q4FY21 at 5.8 per cent. Quite clearly, the scope for rate cuts in the financial year will be difficult under these conditions. It is more likely that rate cuts can be invoked earliest in financial year 2021-22 (FY22).

However, there is assurance given that there will never be an issue on liquidity through various measures. The on-tap TLTRO funds will now be expanded to the 26 sectors identified by the Kamath Committee, as also healthcare. This brings it in alignment with the government’s move to extend the Emergency Credit Line Guarantee Scheme (ELCGS) coverage to these sectors in November. Therefore, the system need not really worry about liquidity.

These measures will actually ensure that while basic regulatory rates have not changed the market yields on bonds will remain stable and the infusion of liquidity as and when required will ensure that they are range bound. This benefit will percolate to corporate bonds, too, as pointed out by the RBI that spreads over G-Secs has returned to the pre-pandemic levels and hence in general borrowing costs should be stable.

The RBI’s take on growth is interesting as it is looking at marginal positive growth in Q3 and Q4. This is based on faster-than-expected recoveries witnessed in several sectors including services. While Q4 forecast is more or less in lines with the market, the Q3 forecast is unique even though growth is to be just 0.1 per cent. This will imply that the RBI expects sustenance of demand in December, too. If this does happen, it can be said that growth in Q4 could be even higher. The overall forecast of -7.5 per cent for the year appears to be in line with CARE Ratings’ estimate of  -7.5-7.7 per cent.

The curious message we get form the statement is that inflation is no longer the only target and we are back to the old days when both growth and inflation were targets for monetary policy. There is, hence, no talk of raising rates even though inflation is going to be well above the 4 per cent mark through the rest of the year. While this could be due to unusual conditions this year, it will need to be seen whether this stance continues into FY22.

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