Abheek Barua*

Abheek Barua

Central Bank Watch: Looking beyond the policy rate, RBI supports growth

  • In line with our expectations, the RBI kept the policy rate unchanged at 5.15% given the recent high inflation prints.
  • The MPC revised its GDP growth forecast down (by 35bps to 5.5-6% for H1 FY21)
  • while revising up its inflation projections to 6.5% for Q4 FY20 and 5.0 -5.4% for H1 FY21
  • RBI kept its stance accommodative and signalled that there is space for future action.
  • RBI announced a number of measures to support growth and boost credit growth (for sectors such as auto, housing and MSMEs)
  • The RBI also announced LTROs of Rs 1,00,000 crore to provide durable liquidity and push credit growth

In today’s policy announcement, while the RBI kept the policy rate unchanged – given the high inflation prints – it announced a number of measures to support growth. The announcement of the LTROs to provide durable liquidity and the CRR relief for on-lending to the auto, the housing and the MSME sector is likely to push credit growth. In an effort to improve transmission, the RBI also announced external benchmarking for medium enterprises.

In terms of the policy rate, the RBI kept its stance as accommodative and signalled that there is space for further rate cuts.  Going forward, our sense is that the central bank could take the first opportunity it gets to cut rates – as soon as the inflation optics start looking better (with vegetable price spikes cooling-off) and headline inflation comes in closer to the RBIs target band. They are likely to rely on the fact that inflation is expected to drop sharply over the next 12 months (estimate at 3.2% in Q2 FY21). We now see a high probability of a rate cut (25bps) as early as Q1 FY21 (Apr-June 2020). (For our latest analysis on inflation and monetary policy see our report: Inflation Vs. Growth, which way is the RBI likely to sway?, 5 February, 2020).

On liquidity, we expect the RBI to keep liquidity in surplus over the coming months. In our opinion, the excess liquidity in the system, along with the announcement of the LTROs, could make it difficult to justify any plain vanilla OMOs (unsterilized) and reduce the possibility of the same.

The bond market reacted positively to todays announcement and the 10 year gained by 5 bps, trading at 6.458% at the time of writing (from yesterdays close of 6.505%). The short-end of the curve recorded a bigger rally with bonds maturing upto 5 years seeing a 15 bps fall in their yields with the announcement of the LTROs. In the short-run, as higher inflation prints in Q4 FY20 are more or less baked in, oil prices are likely to remain contained, and the government borrowing program has been in line with market expectations, the case for a range bound movement in yields tilted downward seems likely.

The Specifics:

  • Growth and Inflation View: The RBI revised down its growth projections for H1 FY21 (by 35bps) to 5.5%-6.0% while revising up its inflation projections for Q4 (to 6.5%) and H1 FY21 (to 5.0-5.4%). We expect growth to come in at 5.8% in H1 FY21 and inflation to come in at 5.5% by the end of H1 FY21. In the second half of the year, we expect inflation readings to fall sharply to 2.3% by December 2020.
  • Tweaks to the Liquidity Management Framework: The RBI removed the daily fixed repo and four 14-day repos conducted every fortnight. Instead, the variable 14-day repo/reverse repo would be the main liquidity management tool.
  • Introducing LTROs (Long Term Repo Operations) to improve transmission and supplying durable liquidity: The RBI shall conduct term repos of one-year and three-year tenors of appropriate sizes for up to a total amount of Rs 1,00,000 crore at the policy repo rate.
  • Other Measures to support growth:
    • CRR relief to boost credit flow: Commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for auto, residential housing and loans to micro, small and medium enterprises from their NDTL for maintenance of cash reserve ratio (CRR).
    • External benchmarking for Medium enterprises to improve transmission: RBI decided to link pricing of loans, by scheduled commercial banks, for the medium enterprises to an external benchmark effective April 1, 2020.
    • Relief for real estate sector: RBI permitted the extension of date of commencement of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another year without downgrading the asset classification. This could help improve last mile funding for real estate projects.

Source- HDFC Bank’s Treasury Research Team has released a report titled “Central Bank Watch: Looking beyond the policy rate, RBI supports growth”

*Mr. Abheek Barua tweets at @AbheekHDFCBank.

Some Comments on RBI Sixth Bi-monthly Monetary Policy Statement, 2019-20

Mr. Siddhartha Mohanty, MD & CEO of LIC Housing Finance said that “We believe RBI Policy announced today will ease the norms to give relief to commercial real estate developers. RBI’s decision about the extension of Date of Commencement of Commercial Operations (DCCO) of project loans for commercial real estate, will provide comfort to companies developing such projects and also their lenders. It will benefit the banks as they will not need to downgrade the asset classification, in line with treatment accorded to other project loans for non-infrastructure sector”.

Mr. Mohit Ralhan, Managing Partner & CIO, TIW Private Equity said that “RBI has continued to keep the  accommodative policy stance. It  has already cut the policy repo rate by 135 bps since Feb last year. However, banks have not passed the rates cut fully to customers. The decrease in requirement of cash reserve ratio for housing, auto and MSME loans for 6 months is a positive move which is likely to result in a better lending environment.”

B Prasanna, Head – Global Markets, Sales, Trading & Research, ICICI Bank sais that “The policy today is a “whatever it takes” moment for India and its policy makers. Several steps taken by the MPC are truly path breaking and shows the willingness of the Governor and the MPC to think laterally. The crowning glory of all measures is the provision of long term money through LTRO at the repo rate that is intended towards facilitating better transmission in the bond and loan markets. Besides lowering rates in the short end of the sovereign curve it is also likely to lower Corporate Bond yields, deposit rates and lending rates. Additionally, leeway provided on CRR on incremental retail loans, extending the scope of external benchmark linked loans, extension of restructuring benefits for MSMEs and commercial real estate will all go a long way towards providing much needed credit to these stressed sectors as well as help in aiding stressed projects.

Even as the MPC retains its accommodative stance and admits to further room for cut(s), it is constrained currently on the policy rate front as inflation remains uncertain and elevated. The MPC has however displayed its clear intent that several instruments are available at its disposal to support growth, ensure adequate systemic liquidity, enable better transmission and channelize better credit flow. Going forward we expect the MPC to react to an evolving growth-inflation situation. While the base case is still for a pause, probability of one cut cannot be ruled out sometime in the second half of the calendar year when inflation is likely to fall towards 4%.”

Mr. Mayank Jalan, President, Indian Chamber of Commerce (ICC) on Sixth Bi-monthly Monetary Policy Statement sais that ” ‘RBI’s repo rate has been kept unchanged at 5.15 per cent  and reverse Repo rate is also unchanged at 4.90 per cent is a welcome decision and appreciated by Indian Chamber of Commerce. Holding the repo and reverse repo rate same comes in consonance with the objective of having “accommodative” stance for reviving growth. It will also stabilize the current investment amid the rising retail inflation and boost consumption. As a Chamber we expect that the holding of the rate will complement the recent measures taken by the Government to boost the economy. The policy will be conducive to achieve the medium term target for consumer price index (CPI) inflation of 4% within a band of +/2 per cent alongside growth. The decision of holding the rates same twice in a row is taken to control the surge in inflation.’

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April 2021