Meeting the market’s expectations and in line with CARE Ratings’ expectations, the Monetary Policy Committee (MPC) maintained status quo in its sixth bi-monthly monetary policy review, retaining the repo rate unchanged at 5.15% while maintaining to stance at ‘accommodative’ citing the growth concerns while ensuring the inflation remains within the RBI’s target range of 4% (+/- 2%). All members voted in favour of the above decision.
The MPC stated that there still remains policy space for future actions. However, the outlook of inflation is uncertain with inflation expected to be 5-5.4% in H1-FY21. For H1-FY21, the economic growth projections have been revised downwards while the inflation projections have been revised upwards even surpassing RBI’s inflation target of 4%.
RBI’s Assessment on global and domestic economy
A. Global scenario
- Slow paced economic growth though getting differentiated across geographies.
- Stable growth in the US with slack in consumer spending though aided by government expenditure
- Slowdown in economic activities in Euro area amid waning consumer confidence and tepid industrial production and retail sales in the UK
- Weakness in the economic performance of emerging markets hampered by sluggish domestic demand and decline in industrial activities.
- Volatile crude oil prices - initial spike in prices led by US Iran tension reverted post outbreak of coronavirus in China raising demand concerns.
- Rising food prices globally
- Trend reversal from bullish sentiments in the early January (US China trade deal and Brexit) to bearish sentiments in the financial markets and softening yields with concerns surrounding spread of coronavirus
- Strength in the US dollar
- Weakness in the EME currencies since the last week of January.
B. Indian economy
RBI’s outlook on inflation and economic growth
Owing to the various upside factors and increase in actual
inflation overshooting projections, the inflation projections
have been revised upwards. In Q4 FY20 and H1 FY21 the
retail inflation is expected to surpass RBI’s inflation target at 4%.
In fact for Q4 it is expected to overshoot RBI’s upper band of 6%
of the inflation target. The factors guiding the inflation trajectory
in the future are listed below.
The MPC however points out that the inflation outlook remains highly uncertain on account of rise in non-food items, core CPI due to increase in telecom charges, freight charges, prices of drugs and pharma and new emission norms. Higher customs duties on some products would also affect core inflation.
Economic growth for FY21 has been pegged at 6% owing to expected recovery in the private consumption especially in the rural areas aided by improved rabi prospects and recent rise in food prices, easing global trade uncertainties encouraging exports and investment activity, progress in the monetary transmission, likely pick up in consumption and investment demand, rationalisation of personal income tax might support the domestic demand along with measures to boost rural and infra spending though a downside could emerge from outbreak of coronavirus in China impacting the tourist arrivals and global trade.
Developmental and regulatory policies
Revision in Liquidity management framework
- Operating target weighted average call rate (WACR)
- Width of the corridor remains unchanged at 50 basis points
- Abolishing the need for specifying a one-sided target for liquidity provision of one percent of net demand and time liabilities (NDTL)
- Withdrawal of daily fixed rate repo and four 14 day term repo while ensuring adequate provision/absorption of liquidity using fixed and variable rate repo/reverse repo auctions, outright open market operations (OMOs), forex swaps and other instruments
- Main liquidity management tool: A 14-day term repo/reverse repo operation at a variable rate
- Longer-term variable rate repo/reverse repo operations of more than 14 days if the need arises
The WACR will have to be monitored to gauge the extent of support to be received from the RBI. This can be through daily or term repo as and when required. The removal of the 1% NDTL limit would work well for banks which require more funding in times of liquidity shortage.
Long Term Repo Operations (LTROs) for Improving Monetary Transmission
- Term repo of 1 year and 3 year tenures of appropriate sizes for up to a total amount of Rs 1,00,000 crore at the policy repo rate fortnightly beginning on February 15, 2020.
- The use of these instruments will depend on a series of factors. First, the banks would look at their cost of funds. Presently the weighted cost of deposits is between 4.8-5% which makes the repo rate seem high from the point of view of taking a long term call of above 1 year. Second, the overall state of liquidity will also be of importance as there are options of going in for shorter term repos to source funding. Third, the expectations of the future are also important. In case rates are expected to come down, banks may not like to lock-in a higher repo rate
Incentivising Bank Credit to Specific Sectors
- Scheduled commercial banks will be allowed to deduct the equivalent of incremental credit disbursed by them as retail loans for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs) over and above o/s as on January 31, 2020 from NDTL and CRR maintenance up to July 31, 2020.
- While this will be beneficial to banks which can be incentivized to lend more to these sectors, the present state of excess liquidity may not really warrant such action on a large scale. However, to the extent that resources are freed from CRR they can be invested even in the reverse repo auctions at the limit to accrue a net gain.
External Benchmarking of New Floating Rate Loans by Banks to Medium Enterprises
- Pricing of loans by scheduled commercial banks for the medium enterprises also to an external benchmark effective April 1, 2020
- This will be useful for medium enterprises which can get loans at rates closer to the benchmark. However it needs to be seen whether or not banks change the spread charged on this benchmark for various enterprises under this category.
Extension of One-time Restructuring Scheme for MSME advances till December 31, 2020
- This gives MSMEs some more time to recoup from the problems that they have been facing so far. The various measures announced by the government and this step taken by the RBI will make them more viable.
Projects under Implementation in Commercial Real Estate sector
- Permit extension of date of commencement of commercial operations (DCCO) of project loans for commercial real estate, delayed for reasons beyond the control of promoters, by another one year without downgrading the asset classification.
This can be taken to be a logical corollary of steps being taken by the RBI against the initiatives taken by the government by setting up the Rs 25,000 cr fund to help developers. This will be beneficial for both banks and borrowers.
- RRBs to act as merchant acquiring banks, using Aadhaar Pay – BHIM app and POS terminals
- Proposed that all rupee IRD transactions of market makers and their related entities globally, shall be accounted for in India to deepen Rupee Interest Rate Derivative Market
- Construct and periodically publish a composite “Digital Payments Index” (DPI) and consider establishing an SelfRegulatory Organisation SRO for the digital payment system by April 2020.
CARE Ratings’ View
The RBI has indicated that there could be rate cuts going ahead but would be data dependent. In the April policy going by the RBI’s forecast inflation would still be high at 5.45% and may not merit this move. It is more likely this would be in course of the year as inflation numbers become more favourable. The growth projection for next year is similar to what the Budget and Economic Survey have spoken of; but one may have to wait for the second half to see a more prominent push to growth. We could expect another 25-50 bps rate cut during the course of FY21 which however will be data dependent
Madan Sabnavis, Chief Economist
Rachna Gupta, Manager – Training