The policy of the Reserve Bank of India (RBI) comes at a critical time when the economy is in the midst of a confused lockdown with different perspectives on growth and a direction set for inflation. The Monetary Policy Committee (MPC) has reiterated the accommodative stance in the past, and so the bottom line is that the repo rate is unlikely to be increased in the near future.
Some of the important signals provided are as follows. First, the growth outlook and here the RBI cut the forecast down to 9.5% which is now closer to what most analysts have done (CARE is 8.8-9%) . Single digit growth looks less attractive than double digit growth. In fact, the rate would decrease over the quarters sequentially. Therefore, it also supports the MPC’s view that growth is weaker than expected and therefore requires the support of the monetary authority.
The second view is on inflation, which remains unchanged at 5.1 percent for the year. This may need to be stepped up given that a major concern today has been the rise in global prices of commodities, which are not only metals but also oils – edibles and fuels. The World Bank has been talking about big increases this year, which was already seen in the WPI last month (although it is true that the low base has played its part). There is also the bet that food prices will remain stable with a good monsoon forecast.
Third, is about liquidity. This has been a major driving factor in the system with various liquidity incentives announced even in May. The RBI has kept pace with the measures announced this time around as well. A signal that needs to be raised is that the Special Long Term Repo Operation (SLTRO) has not elicited a response from the banks as only Rs 400 crore was recovered in the first auction. There is an addition of Rs 15,000 crore for high contact sectors like hotels, tourism etc which is very necessary and more likely to be successful as this segment has been shaken twice. As most would fall under the SME category, this will be helpful.
The second phase of the government securities acquisition program (GSAP 2.0) was more or less as expected, as the RBI will continue to purchase more paper to support the system. Interestingly, the government would also borrow about 1.5 trillion more rupees this time around to compensate states for GST collection deficits. Thus, the total of Rs 2.2 trillion of GSAP in the first half of the year will help support this operation.
On liquidity, the RBI seems to persevere in its dual objective. The first is to keep the system in surplus even after meeting all the requirements of the borrowers. This has been done successfully throughout the last year and this year so far given the large daily flows to reverse repo auctions. The other is to actually work on the yield curve to make sure it performs well. It also means that yields will remain low, which is in the best interest of the government as there is a large borrowing program that needs to be facilitated this year. These measures will certainly make it possible to achieve this objective. The yield on 10-year bonds will therefore remain around 6%.
One point made by the RBI was to pay attention to the banks’ provision requirement and capital buffers. It might just indicate some concern about the possible increase in stressed assets this time around due to the lockdown due to Wave 2.
The market reaction has been quite stoic. There isn’t much change in the frontline indices: the currency is still around 73 and the 10-year yield barely crosses 6%.
(Madan Sabnavis is Chief Economist at CARE Ratings and author of “Hits & Misses: The Indian Banking Story”. The opinions expressed in the article are his own.)