Union Budget 2021, with a sharp focus on growth revival, cheered investors in Indian markets.
Abundant liquidity, promise of massive infra push and announcement on privatisation ticked all the right boxes for stock markets. The next big trigger is the Reserve Bank of India (RBI) policy outcome on February 5.
Most economists expect the Monetary Policy Committee (MPC), the rate-setting panel, to vote in favour of a pause on February 5 and continue with the accommodative stance.
That wouldn’t be a surprise for markets.
In the previous rounds, the MPC has left enough hints to convey that reviving growth is the priority and the panel will remain on an accommodative stance "as long as necessary". After a growth supportive Union Budget, the MPC is unlikely to spoil the party too soon.
In all likelihood, the RBI is expected to announce a pause and continue with the accommodative stance.
What needs to be watched is the central bank's move on the liquidity front. The RBI may announce some early measures to gradually drain the excess liquidity from the banking system. When and how is the question.
“Considering the threat arising from surplus liquidity on inflation, we expect the RBI to focus on squeezing excess liquidity from the system,” said M Govinda Rao, Chief Economic Adviser at Brickwork ratings.
“As there is an unprecedented slump in economic activities caused due to the pandemic, the MPC is likely to continue with its accommodative monetary policy stance and hold the repo rate unchanged at 4 percent till the time the economy gets back to the growth trajectory,” Rao said.
A rate cut is out of question for now.
Since March 2020 (when the pandemic began), the MPC has cut the key lending rate, repo, by 115 basis points. Since February 2019, the rate cuts amount to 250 bps. One bps is one-hundredth of a percentage point. Banks have significantly passed on the benefit of rate cuts to end borrowers subsequently. Still, the central bank may wait to see the full transmission of the policy rates before acting further.
How will the RBI drain the excess liquidity?
That will be a tricky decision.
Bond markets are already spooked with the elevated market borrowings that have accompanied a growth-focused budget. The government will borrow Rs 12.05 lakh crore from the market in 2021-22, lower than the Rs 12.80 lakh crore estimated for the current financial year.
According to the Revised Estimate, the gross borrowing for the current financial year was raised to Rs 12.8 lakh crore as against the Budget Estimate of Rs 7.8 lakh crore, registering an increase of 64 percent.
“The unintended financial tightening amid a nascent growth recovery is neither optimal nor desirable at the current juncture. The upcoming RBI policy will likely to be vociferous on communication on being the heavy-duty balancing factor in Gsec demand-supply ahead,” said Emkay Research in a note.
“We reckon there seems much ado about fiscal dominance of the monetary policy in the current context and monetary policy complementarity is presently needed,” said the note.
The yield on 10-year bonds jumped 15 bps following the Budget announcement. In this context, the RBI may not want to disturb the markets further with harsh tightening measures. Still, the central bank may announce certain measures such as MSS Bonds to manage the liquidity situation, economists expect.
The RBI governor, in the recent past, has acknowledged the fact that a premature withdrawal of liquidity will be detrimental to growth. Markets are pinning hopes on this promise. Madan Sabnavis, Chief Economist of CARE Rating agency, said the central bank is unlikely to announce measures to tighten liquidity in this policy.
There is good news on the inflation front. India's Consumer Price Index (CPI), which measures the country's retail inflation, eased to 4.59 percent in December versus 6.93 percent in November, within the RBI's upper band of 6. The Consumer Food Price Index (CFPI) or the inflation in the food basket, eased to 3.41 percent in the month of December, down from 9.50 percent in November. That is a comforting factor for the rate-setting panel.
The economy is growing, albeit, slowly. The latest PMI data signals some optimism in the recent months. Bank lending has picked up slowly and restructuring figures show companies are showing better-than-expected recovery. But, the overall growth scenario remains fragile. The economy, facing a contraction this year, is severely hit by the pandemic. Sudden withdrawal of liquidity could hurt the recovery process and spook financial markets.
The MPC is unlikely to take that risk for now.
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