The fourth monetary policy of FY21 presented on October 09, 2020 was special in that it was presented with 50% first-time members. Ashima Goyal, Shashank Bhide and JR Varma are war veterans in market structure and macroeconomics and bring a rich external perspective to the table. However, the policy expectations were quite limited.
Inflation remained sticky above the 6% mark giving limited leeway to the MPC to cut rates. The repo rates at 25-year lows only created a recipe for status quo. The only thing that was of interest to the markets was whether the policy would clearly spell out a dovish stance. It is in this background that the MPC presented the Monetary Policy on 09 October.
Highlights of the Monetary Policy, Oct-20
Here are some of the key highlights of the monetary policy announcement.
• As expected, the Monetary Policy Committee (MPC) opted to maintain status quo on repo rates at 4.00% and reverse repo rate at 3.35%.
• Consequently, the bank rate and the MSF (Marginal Standing Facility) rate remained static at 4.25% (25 bps spread over repo rate).
• MPC decided to retain the accommodative stance of the monetary policy hinting that it had no intent of changing the stance till mid-2021.
• The key takeaway was the use of the term “as long as necessary” in the accommodative stance till “durable growth” returned.
• The decision for status quo on rates was unanimous while Jayant Varma alone voted against assuring accommodation for a prolonged period.
Limited visibility of growth revival, says MPC
The October monetary policy comes in the background of the recent GDP data of -23.9% in the Jun-20 quarter. India’s GDP contraction in Jun-20 quarter was the worst compared to other large economies. Most of the global rating agencies and research houses have downgraded India’s full year GDP contraction for FY21 to (-11%). That left MPC with little choice but to maintain an accommodative stance till there were durable indications that growth was turning around.
MPC has pointed out that the sharp spike in liquidity was driven by a 13.5% increase in reserve money on a YOY basis and a 21% increase in currency demand. In a nutshell, the liquidity concerns had been addressed although the impact on growth may take longer. High frequency indicators like PMI and core sector are hinting at output reaching 90% of pre-COVID levels. But the real struggle could start from this point as weak demand and supply chain constraints play spoilsport.
Balancing inflation reality and growth demands
Inflation at 6.7% for July-August period is not conducive to rate cuts. The best that the MPC could do was to maintain status quo on rates. However, RBI has pointed out that the Kharif output would start coming into mandis from Oct-20. That is when food inflation tapers. A different animal in the form of post-COVID rural supply chains could be the big X-factor.That is why MPC is apprehensive that inflation could remain elevated despite the Kharif inflows. RBI estimates inflation to remain above 5%, all the way to March 2021.
In a nutshell, there is a high probability that inflation concerns can last longer than anticipated. There was also a high probability that GDP growth may take longer to recover. RBIestimates India’s real GDP to contract by -9.8% in Q2 and -5.6% in Q3 resulting in FY21 contraction of -9.5%. However, RBI is projecting GDP growth to pick up to +20.6% in FY22, but that would not be possible without a sustained low repo rate regime. That clearly makes the case for continued accommodation.
Primary focus on recovering from the COVID-19 shock
If there is one underlying focus in the monetary policy, it is to recover from the shock of the Coronavirus pandemic. That has impacted the Indian economy and businesses at multiple levels. The undertone of the MPC was that high inflation was an outcome of supply shocks and that need not be a barrier to a prolonged accommodative policy. MPC is also betting that over the next few months the supply chains should stabilize and economic activity should normalize justifying the current stance of the MPC. However, till the time inflation tapers, the MPC would focus on supporting economic growth through the three engines of liquidity infusion, better transmission and catalyzing fiscal thrust.
Reforms beyond the monetary numbers
The RBI has also stretched itself beyond the normal policy announcements. Here is how.
• RBI will now conduct on-tap TLTRO up to Rs1 trillion at a floating rate linked to the policy repo rate. This is part of routine liquidity management.
• RBI will conduct open market operations (OMOs) in state development loans (SDL) in this financial year to improve liquidity in SDLs and facilitate transparent pricing.
• Automatic caution listing of exporters to be withdrawn to make the system exporter friendly. Caution listing will only be done on the recommendation of the AD bank.
• LTV risk weights rationalized for home loans at 35% for LTV less than 80% and at 50% for LTV more than 80%. This will help realty sector.
• Effective Dec-20, RTGS will also be available round the clock and through the week. India will be one of the few countries to have 24x7 NEFT and RTGS facilities.