MPC | A cautious pause, focus on financial stability

The rate action in the August meeting was a close call and the Monetary Policy Committee's (MPC’s) decision to keep both repo and reverse repo rates steady was not a major surprise. The June CPI print above the RBI’s upper tolerance band had infused some doubt about whether the MPC delivers another cut in this round.

However, while the rate action in the August policy was admittedly a close call, a calibrated cut was our baseline expectation, given continued uncertainties about recovery in economic activities.

Thus, the unanimous 6-0 voting of MPC members in favour of a pause was a surprise. This is despite the central bank continuing with an ‘accommodative’ policy stance, as expected. However, the RBI’s statement indicated that it remains open to utilise the space for further cuts in future, even though the central bank tried to temper expectations on this count at the moment.

More Rate Cuts Likely In H2

On balance, while the RBI is certainly not willing to rush into further rate cuts, it is clearly felt that the central bank is not done with cutting rates either — given the stark weakness in growth and likely softening in CPI prints during the second half of the current fiscal year, one expects more rate cuts during H2 2020-21 even from the current levels of near historic lows.

While the early-summer rate cuts were targeted at providing immediate relief and cushion to sentiment in the pandemic-struck economy, the MPC will likely consider delivering the next rounds of cuts when it can potentially be more effective in reviving economic activities. The upside surprise in the June CPI print was driven largely due to intermittent supply disruptions and was far from any demand overheating. While optically even core inflation was higher, items such as precious metals made a meaningful contribution. One feels that CPI inflation will likely be in the range of 3-4 percent during larger part of H2 2020-21.

RBI Provides Support

While the central bank has not come out with it growth forecasts explicitly, the RBI’s Financial Stability Report, released a couple of weeks ago, indicated its baseline expectation of a mid-single digit contraction in 2020-21 GDP. However, further downside risks to such forecasts cannot be ruled out; increasingly, a larger number of forecasters are now fearing double-digit contraction in real GDP during the current financial year, even after taking into account likelihood of a materially better H2 than the first six months of the year.

Against such a backdrop, the RBI continued using the space available with its developmental and regulatory policies to boost liquidity support for the financial system, targeting better flow of credit. As expected, the RBI refrained from any further extension of the ongoing moratorium, which is currently scheduled to be over by the end of August.

On the other hand, stressed MSME borrowers will now be eligible for restructuring of their debt, subject to meeting a set of criteria, including being classified as standard assets as on March 1, 2020. One also welcomes the RBI’s announcements today of additional special liquidity facility of ₹5,000 core each to NABARD and NHB.

It is felt that while the RBI has already lowered interest rates and has provided a large quantum of liquidity in recent months, targeted liquidity operations — such as the TLTROs (Targeted Long Term Repo Operations) — hold the key for a quicker recovery. In this context, it will be of immense help if the central bank provides focussed support to the lower end of the economic pyramid, including for sectors such as microfinance, MSMEs and affordable housing.

Fiscal Spending Critical To Recovery

The RBI’s announcements offered limited immediate cheer for the bond market, barring the mention of likelihood of OMO purchases. However, it is important to note that revival in economic activities in the coming quarters will remain critically dependent on fiscal policy support and steps by the RBI as the debt manager of the government can potentially play a critical role in managing bond market sentiment.

In that context, one would recommend evaluating a number of potential measures over the coming months, such as (a) elongating the maturity profile of the government’s liabilities, especially given the current low interest rates (b) issuing larger quantum of securities in the benchmark 10-year bucket to ensure better liquidity in this segment and (c) allowing greater flexibility for the held-to-maturity (HTM) books of banks.

Such measures collectively can create a more conducive situation for sailing through a larger quantum of fiscal borrowing in the current year, which is clearly on the cards.

Siddhartha Sanyal is Chief Economist and Head of Research, Bandhan Bank. Views are personal.