The Reserve Bank of India undertook a well-rounded and calibrated approach on June 4, with the monetary policy committee (MPC) voting unanimously to keep rates on hold, whilst much of the focus, as we expected, was on aspects beyond mainstream rates. We capture the essence of the policy review in three “Ms”.
Firstly, the economic assessment was marked to Market, as evolving risks of the second wave was captured by a downward revision in growth projections, whilst inflation estimates were dialled up a notch.
The FY22 growth forecast has been lowered by 100bps to 9.5 percent YoY, where we stand as well, with the June quarter GDP growth now seen at sub-20 percent and 6-8 percent in the rest of the three quarters.
On sequential basis, the June quarter is likely to mark the trough, with gradual improvement thereafter. The non-linear approach in the imposition of restrictions and unwinding thereafter lends itself to uncertainty on the normalisation path.
Progress of variants and vaccinations are the primary unknowns but the evolving case curve and assurances of strong supplies in the second half of 2021 suggest we are past the worst point of the spread.
Inflation projections were adjusted up, higher than our forecast. Supply-side disruptions and labour market dislocations have been contained during the second wave, but there are anecdotal signs that selected non-food categories, especially medical inputs and hospitalisation costs, have risen this quarter. Add to this is the spillover from high commodity prices, underpinning non-food manufacturing price inflation.
The extent to which high WPI will spill into CPI inflation hinges on the ability of producers to pass on the higher inputs costs, which, at this juncture, is unlikely given weak demand conditions, thereby impacting corporate margins to a greater extent than retail prices.
The second is Managing the financial fallout for smaller businesses and the worst-hit contact-intensive sectors. Towards this, a separate liquidity window of Rs 15,000 crore was provided for selected sectors, with banks allowed to park their surplus liquidity up to the size of the Covid book at 40bps above the reverse repo rate.
Additionally, a larger set of borrowers will henceforth be able to avail of the benefits under resolution framework 2.0, as the maximum aggregate exposure threshold was lifted to Rs 50 crore for MSMEs, small businesses and loans to individuals.
Liquidity support and credit guarantees are being extended by the central bank and the government to affected businesses and sectors, which might help tide over working capital needs but not address deeper risks of business viability or solvency.
Lastly, ensuring Market stability has been a key element in the central bank's toolkit. For the bond markets, the remaining tranche of GSAP 1.0 ie Rs 40,000 crore will be conducted in mid-June, a fourth of which will comprise state development loans (SDL) purchases.
Add to this, the size of GSAP 2.0 for the September quarter has been enhanced to Rs 1.2 lakh crore, helping to guide borrowing costs lower and likely offset any potential fallout from global externalities, eg US Federal Reserve policy guidance. More support has to be forthcoming as the Centre’s budgeted Rs 12 lakh crore gross borrowings are set to rise further on transfers to states for revenue shortfalls.
The two-way presence in the FX markets via spot, forwards, and futures, whilst catching participants' off guard, is seen as a necessary accompaniment to pursue domestic objectives and strengthen the reserves stock, which likely surpassed $600 billion this week.
Reserves have jumped by over $135 billion since early 2020, registering among the highest increases in the region. More importantly, we also sensed a likely elevation in reserves accretion as a priority for the central bank, not merely conjoined with the FX movements.
The rupee is fairly volatile in the face of externalities (for instance episodes of USD bounce) but more recently witnessed a stronger fundamentals tailwind (reserves, narrower current account gap, etc) which has helped the unit to retreat from extremes. Broadly, we expect the USD-INR uptrend to be maintained this year on an anticipated dollar upmove in Q3, but with a less steep gradient.
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