A confidence boosting monetary policy

Despite a status quo in the policy repo rate, the first monetary policy of the newly-appointed Monetary Policy Committee (MPC) continues to stay dovish. Besides the usual policy statement, the governor’s statement defines the context of the policy in a transparent fashion. After all, ‘communication’ from the central bank is an important tool to guide expectations.

For the first time in the current financial year, the MPC has given its macroeconomic projections for the remaining part of the financial year 2020-21 (FY21) and the first quarter of FY22. As regards inflation, the committee sees inflationary risks getting mitigated by progressive easing of lockdowns and removal of inter-state transport restrictions. Healthy agricultural harvest and weak pricing power of firms are also expected to help. Hence, the CPI inflation is projected to ease from 6.8 percent in Q2, FY21 to 4.5-5.4 percent in H2, FY21 and 4.3 percent in Q1, FY22.

Factoring in the underlying growth impulses in a few select sectors and the uncertain COVID-19 trajectory, the MPC expects economic growth to re-enter positive zone in Q4, FY21 at 0.5 percent after staying negative in the previous three quarters. The full year FY21 will see a growth contraction of 9.5 percent before a rebound of 20.6 percent in Q1, FY222 to be aided by a favourable base effect.

Major growth driving sectors during the ongoing pandemic identified by the MPC are agriculture and allied activities, fast moving consumer goods, two wheelers, passenger vehicles, tractors, drugs and pharmaceuticals, and electricity generation especially renewables. Even the RBI’s latest surveys on consumer confidence, business and inflation expectations signal favourable conditions in the second quarter as compared to the first quarter of the year FY21. This is certainly encouraging and confidence boosting.

The MPC has retained the policy stance at ‘accommodative’ with an assurance that it will be retained at ‘accommodative’ at least during the current financial year and into the next financial year to revive growth on a durable basis albeit without compromising on inflation.

While five members of the new MPC have voted in favour of this formulation, JR Varma has refrained from giving an indefinite commitment to the central bank’s quantitative easing (QE) programme. It will be interesting to read his commentary, when the RBI will release the ‘minutes’ on October 23.

Recognising the growing disconnect between the rationale behind the RBI’s debt management policy and the market expectations, the governor assured market participants in his forward guidance that the RBI will maintain comfortable liquidity conditions and conduct market operations in the form of outright and special open market operations (OMOs).

Consistent with its past actions, the RBI announced several unconventional measures on October 9, like increasing the quantum of OMOs for central government securities to Rs 200 billion from Rs 100 billion, and including state development loans (SDLs) in special OMOs, etc. to encourage market participants to invest in these bonds and support the large-sized borrowings programme.

According to treasury experts, this may help ease the cost of borrowing for state governments and reduce the spreads too for corporate bonds. In response to these announcements, the government bonds have gained significantly. However, the future trajectory of yields will be driven by how frequently the RBI conducts such OMO operations.

Other measures such as on-tap TLTRO, introduction of round the clock RTGS facility, co-origination of priority sector loans between banks and NBFCs/HFCs and measures to boost export and housing loans are very encouraging and supportive of growth.

The RBI also extended the dispensation of enhanced HTM limits of 22 percent up to March 31, 2022 for securities acquired between September 1 and March 31, 2021. According to market risk professionals, while this move is intended to improve banks’ participation in auctions, it will only postpone the interest rate shock by banks.

To conclude, the first policy of the new MPC members has appropriately focused on growth revival with the support of unconventional monetary measures and bold regulatory measures from the RBI. The commentary on current conditions and forward guidance from the governor is transparent and encouraging.

However, the absence of guidance on how RBI would untangle itself from a mix of yield-curve control and OMOs when the economy is back to the normal growth path would weigh on the sentiment of long-term investors.

Rupa Rege Nitsure is Group Chief Economist, L&T Financial Services. Views are personal.