Monetary Policy | All about transmission and credit push?

Everyone and his uncle expected the Reserve Bank (RBI) to hold rates in the policy on February 6 even though there was some difference of opinion over the expected stance. The RBI obliged; the decision to hold rates and continue with the accommodative stance was unanimous, with all the six MPC (Monetary Policy Committee) members voting in favour.

The central bank continued to maintain its dovish policy stance, but it highlighted that “there is policy space available for future action”, saying it would “persevere with an accommodative stance as long as necessary to revive growth while ensuring that inflation remains within the target”.

The real story of the policy, however, is its emphasis on liquidity transmission and an attempt to impart sector-specific credit boost, which came in the Developmental and Regulatory Policies statement.

The RBI has introduced long-term repo operations (LTROs) of 1-3-year tenor up to Rs 1 lakh-crore. This has been a long-standing demand to provide durable liquidity to the system. This measure addresses supply-side issues by boosting the availability of durable liquidity; it will help banks lock in their funding costs at 5.15 percent for a longer period and aid maturity transformation.

The key concern is that given the scenario of weak demand for funds, will banks indulge in lazy banking or arbitrage by borrowing money from the RBI and parking it in G-secs instead of lending it to customers? It is likely that the impact of this measure will manifest in the money market channel first and impart a push to credit growth as a second order effect.  Note, 5-year yields have already come off a tad, post the announcement.

The RBI also came up with a regulatory CRR (cash reserve ratio) leeway for incremental credit to specific sectors such as automobiles, real estate and loans to MSMEs (Micro, Small and Medium Enterprises) and Extension of One-time Restructuring Scheme for MSME advances.

From a macro standpoint, there a few important takeaways:

• Fiscal numbers and the Budget: The RBI has chosen to see the government’s breach of the fiscal deficit through the lens of the bond markets and has taken it at face value.
• Inflation: Near-term inflation projections have been revised upwards quite sharply, in accordance with the sharp rise in inflation in the past two months. However, it clearly believes that the spike is likely to be short-lived and has accordingly maintained an extremely dovish commentary. Our inflation projections for H1 FY21 are in line with the RBI’s numbers. However, our Q3 FY21 estimate is slightly higher at ~4percent as against the RBI’s estimate of 3.2 percent.
• Monetary Transmission: There has been some improvement on this front in recent months. As against the cumulative policy repo rate reduction of 135 bps (basis points) since February 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by 69 bps. However, the WALR on outstanding rupee loans increased by 13 bps during the same period. The 1-year median MCLR (Marginal Cost of Funds-based Lending Rate) has fallen by 55 bps. Further, transmission would be key to support growth.
• External benchmark update: The RBI also said that after the introduction of the external benchmark system, most banks have linked their lending rates for housing, personal and micro and small enterprises (MSEs) to the repo rate. The WALRs of domestic banks on fresh rupee loans declined by 18 bps for housing loans, 87 bps for vehicle loans and 23 bps for loans to MSMEs.
• Growth dynamics: On growth, the RBI, while lowering its forecast for H1 FY21 a bit, has reiterated the widespread expectation that the recovery will be very gradual and U-shaped.

Overall, the RBI is likely to maintain its accommodative stance through FY21 and any space for a rate cut may open up once there is clarity on the monsoons. While the lagged impact of rate cuts would support growth, we believe that conventional monetary policy has reached its limits in the near term.

Monetary easing would need to be supported by targeted fiscal spending to support growth.