Moneycontrol PRO

'Do not expect positive growth in Q4FY21; RBI will use OMOs, other tools to keep a lid on bond yields'

The RBI has taken a number of measures to (i) keep a lid on yields and (ii) increase the absorptive capacity for government bonds.

October 13, 2020 / 12:02 PM IST

Although some sectors of the economy are benefitting from the "Unlock" process, we expect activity in contact-intensive services sector to remain muted in all quarters of FY21. Hence, given the current COVID-19 situation, we do not expect positive growth in Q4FY21, Anagha Deodhar, Economist at ICICI Securities said in an interview to Moneycontrol's Sunil Shankar Matkar.

Edited excerpts:

Q: Can the economic contraction end by Q4FY21?

RBI model suggests that the economy is likely to contract 9.8 percent in Q2FY21, 5.6 percent in Q3 and post a modest positive growth of 0.5 percent in Q4, thereby taking full-year growth for FY21 to -9.5 percent. Latest round of the central bank's Professional Forecasters' Survey also indicates that professional forecasters expect the economy to grow 0.6 percent in Q4FY21.

However, we remain sceptical about positive growth in Q4 for a number of reasons. Firstly, these forecasts seem to be based on optimistic assumptions of a COVID-19 vaccine being found quickly and resultantly quick normalization of activity. Secondly, the forecasts do not take into account the possibility of a second wave and its impact on global growth.

Close

India's (and the world's) battle with COVID-19 is far from over. Many advanced economies are witnessing second wave of the virus while in India infections are rising unabatedly. Hence, although some sectors of the economy are benefitting from the "Unlock" process, we expect activity in contact-intensive services sector to remain muted in all quarters of FY21. Hence, given the current COVID-19 situation, we do not expect positive growth in Q4FY21.

Q: Can we expect any further measures from RBI to boost economy in the coming months?

We saw in the last few policy reviews that although the MPC could not cut rates due to high inflation, it used other tools in its arsenal to provide liquidity and improve credit flows to specific sectors. In October 2020 review, the central bank's decision to increase open market operations (OMOs) amount to Rs 20,000 crore, and conducting OMOs in state development loans was a big positive for the bond market.

In the future, we expect the RBI to continue supporting financial conditions using a combination of the following tools: (i) Extensive use of TLTRO: RBI has been using TLTROs to enable banks to borrow cheaply and lend to specific sectors. We expect it to increase the quantum and scope of TLTROs if recovery is weaker than expected (ii) Adjust risk weights on specific sectors: If credit flow to sectors with high growth multipliers continues to be low, we expect the RBI to adjust risk weights again to nudge banks to lend to these sectors (ii) Strong forward guidance: In the past few months, we saw G-sec auctions devolve on primary dealers. I call it the RBI's version of 'indirect' yield curve control.

Strong forward guidance – signalling to the market that interest rates will remain low, stance will remain accommodative, government borrowing will be managed efficiently, and RBI will use OMOs and other tools to keep a lid on yields – is an effective strategy.

Q: Given the accommodative stance, do you expect rate cut in second half of FY21? What are your thoughts on the recent RBI policy?

I believe the room for rate cuts has been almost exhausted. If inflation evolves along the RBI's expected trajectory and falls to 4.5 percent during Q4FY21, there could be room for a residual rate cut of 25bps in the February 2021 review.

Q: Given the weak fiscal position, do you still expect another stimulus package from the government as it was one of reasons behind the recent rally in the equity market?

More stimulus is certainly required to aid the fragile recovery. High-frequency data shows that there have been large-scale job and income losses. Hence, it is possible that the current pick-up in activity is nothing but pent-up demand entering the market and that it may not sustain for long.

The stimulus during lockdown and early stages of Unlock was aimed at keeping troubled companies and sectors afloat amidst complete demand destruction. On the contrary, we expect the next stimulus package to focus on reviving or aiding demand as people step out and spend.

While it is true that there are fiscal constraints, the market has already priced in large slippage. The government also realises that it is far more important to quickly revive the economy. We could see some rationalisation of expenditure by low-priority ministries and the resources thus saved could be used for demand-side stimulus in the near future.

Q: Can you explain what the measures taken by the RBI mean for the bond markets?

The RBI has taken a number of measures to (i) keep a lid on yields and (ii) increase the absorptive capacity for government bonds. As I mentioned previously, devolvement of G-sec auction on PDs, announcement of OMOs when yields cross a particular level, etc. are a part of RBI's 'indirect' yield curve control. In October 2020 review, it decided to increase the OMO limit to Rs 20,000 crore. For state bonds, OMOs in SDLs was thought to be a bold and potentially controversial move. Yet, the RBI decided to go for it to create demand for these bonds. Extending dispensation of increased HTM limit for SLR securities is another example of the RBI creating absorptive capacity for government bonds.

Hence, the central bank is using a series of measures to conduct the government borrowing programme in an efficient, non-disruptive manner.

Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Sunil Shankar Matkar
first published: Oct 13, 2020 12:02 pm

stay updated

Get Daily News on your Browser
Sections
ISO 27001 - BSI Assurance Mark