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RBI MPC to stay put on rates through 2021 unless inflation falls sharply: ICICI Securities

By committing to 'lower-for-longer' rates the MPC wants to keep financial conditions easy so that it can support recovery.

December 06, 2020 / 11:14 AM IST

Inflation is likely to remain elevated. This is because, inflation in the recent past has been driven mostly by supply constraints. Our analysis shows that perishables inflation accounted for 43 percent of total inflation during March-October 2020, sharply up from 34 percent during March-October 2019, said Anagha Deodhar, Economist at ICICI Securities in an interview to Moneycontrol's Sunil Shankar Matkar.

Given the expected inflation trajectory in the remaining months of FY21 and FY22, we do not believe the MPC has room to cut rates, she said.

Edited Excerpts:

Q: What are your thoughts on RBI policy and why did the RBI keep repo rate unchanged and maintain accommodative stance?

Inflation in India has been uncomfortably high since the beginning of 2020. During January-October 2020, retail inflation averaged 6.8 percent while since the onset of COVID-19 (April-October) it averaged 6.9 percent. This is 80-90bps above the upper limit of MPC's tolerance band.

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Moreover, there are no signs of inflation moderating meaningfully in the coming months. Given the fact that the MPC's primary mandate is controlling inflation, its decision to hold rates is along expected lines. It also unanimously decided to keep the stance accommodative 'at least in the current financial year and into the next financial year'.

I think a firm calendar-based forward guidance is very important in anchoring market expectations. By committing to 'lower-for-longer' rates the MPC wants to keep financial conditions easy so that it can support recovery.

Q: RBI revised growth forecast upwards. Do you think India can meet these RBI projections? What is your forecast for second half of FY21 and FY22, and what is the basis for the same?

The MPC expects growth to come in at 0.1 percent in Q3 and 0.7 percent in Q4FY21. This is a sharp upward revision from the October 2020 review when it expected growth to print a modest positive number only in Q4. Growth impulses have been stronger-than-expected in the recent past and if economic activity keeps recovering at this pace, it is possible that both Q3 and Q4 will record small positive numbers.

Q: Majority of experts feel the inflation may remain elevated. Do you feel so, and why?

Yes, inflation is likely to remain elevated. This is because, inflation in the recent past has been driven mostly by supply constraints. Our analysis shows that perishables inflation accounted for 43 percent of total inflation during March-October 2020, sharply up from 34 percent during March-October 2019. This shows that lack of proper supply chains and warehousing infrastructure has contributed heavily to pushing up headline inflation. Moreover, the wedge between wholesale and retail prices shows that traders are charging high margins to consumers. We do not expect these issues to get resolved quickly. Sustained high inflation can also feed into households' inflation expectations and lead to generalisation of price pressures.

Q: Do you still expect the RBI to cut repo rate in coming policy meetings given its accommodative stance?

I think accommodative stance is more relevant from signalling perspective – the MPC is telling the market that it will keep rates low in the foreseeable future until the economy is firmly and sustainably on the recovery path. In my opinion, accommodative stance does not necessarily mean more rate cuts are in the offing.

Given the expected inflation trajectory in the remaining months of FY21 and FY22, we do not believe the MPC has room to cut rates. Hence, I believe MPC will stay put on rates through 2021 unless inflation outcomes sharply deviate from the expected trajectory on the downside.

Q: What are your thoughts on additional measures announced by RBI in December policy meeting? Do you expect more measures from RBI in coming policy meetings for banks and NBFCs, and for revival of economic growth?

Since the onset of COVID-19, the RBI has been using other tools in its arsenal outside the purview of monetary policy in order to minimize the impact of the pandemic on the economy. In December 2020, it continued to do so. Extension of 'on tap TLTRO' to include sectors identified by the Kamath committee is a good move. At a time when bank credit growth is weak, making cheap funds available to banks to lend to vulnerable sectors is a welcome move. The central bank also continued its focus on conserving bank capital as it forbade banks from declaring dividend for FY20. Notably, central banks in many countries have banned dividend distribution by banks during COVID-19. It is prudent on the RBI's part to protect banking sector's health during this crisis. Another important announcement was scale-based regulatory framework for NBFCs. NBFCs are becoming increasingly interconnected and important source of finance for the economy. Hence, I believe their role and operations will be closely monitored by the central bank.

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: Dec 6, 2020 10:35 am

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