Even before the Monetary Policy Committee (MPC) commenced its 3-day meet on 02 December, there was consensus in the market that repo rates would be held at 4%. The reasons were obvious. Repo rates are already at 25-year lows giving little room for further monetary manoeuvre. Secondly, the Inflation touched a 6-year high of 7.61% in Oct-20 and that did not encourage further repo rate cuts. MPC, in its last meeting, had already underlined that it would hold rates even if inflation trended higher.
The concern was on the monetary stance. The RBI had maintained anaccommodative stance but there were lurking fears that the MPC may hint at a shift. Fortunately, the MPC held on to its accommodative stance.
Key takeaways from the monetary policy announcement
The following were the key highlights of the penultimate monetary policy of FY21 announced by the RBI.
• The RBI maintained status quo by holding repo rates at 4%. In the Apr-20 and Jun-20 policies, MPC had cut rates by 115 bps as an emergency measure to combat COVID.
• As a result of the status quo on rates, the reverse repo rate also stayed put at 3.35% while the marginal standing facility (MSF) rate and bank rate stood at 4.25%.
• The MPC once again underlined its decision to keep the monetary policy stance “accommodative” for as long as required to catalyze economic recovery.
• RBI upgraded its real GDP growth estimates to -7.5% from around -9.5% in the previous policy, hinting at a front-ending of the economic recovery.
• All the six members of the MPC voted in favour of keeping the repo rates unchanged at 4% levels for now.
• MPC members also voted unanimously to keep the monetary stance accommodative, as against the previous policy when Prof. Jayanth Varma had objected to the idea.
Accommodative stance to help catalyze GDP recovery
The RBI decision to hold repo rates at 4% and the decision to retain the accommodative stance was driven by the twin factors of inflation and GDP growth. Let us look at how the outlook for inflation and growth inspired the policy stance.
Piecing together the inflation and growth puzzle
After retail inflation touched a high of 7.61% in October, the RBI has admitted in its latest policy that the CPI number was worse than expected over last two months. To an extent, the huge gap between CPI and WPI inflation was indicative of the supply chain constraints, which is more of a medium term challenge. The MPC expects the prices of cereals and vegetables to taper on the back of bumper Kharif harvest this year.
However, other food items may remain under pressure. Core inflation has been another worry and with Brent Crude close to $50/bbl, the downstream impact on inflation could be sharp. RBI expects inflation at 6.8% in Q3 and 5.8% in Q4 of FY21. Even in the first 2 quarters of FY22, CPI inflation is expected to remain elevated at 5.2% and 4.6%; well above the RBI desired goal of 4%.
Let us look at GDP projections now. RBI upgraded its GDP contraction forecast to -7.5%, which is a fairly rapid upgrade and leaves room for a bounce in Q3 and Q4 of FY21. Already, rural demand has led the GDP recovery and urban activity is likely to catch up as unlocking becomes more rampant.
However, private investments and exports remain the two big gaps in the recovery story. RBI estimates that GDP to grow at +0.1% and +0.7% in Q3 and Q4 of FY21. This GDP growth is likely to increase to +21.9% in Q1 of FY22 and +6.5% in Q2. GDP expansion is expected to moderate thereafter. RBI is expecting some front-ending of the growth recovery and needs to maintain an accommodative monetary approach that is catalytic to this recovery.
With the RBI hinting at sustained accommodation during FY21 and the first half of FY22, there is no immediate risk of any rate hike or liquidity tightening, even in the face of higher inflation. Going ahead, inflation will be targeted more via liquidity measures and by addressing supply side bottlenecks.
Going beyond rates and liquidity
Like on previous occasions, the fifth monetary policy of FY21 focused on some additional areas of monetary reforms.
• The liquidity adjustment facility (LAF) will be extended to regional rural banks (RRBs) to facilitate more effective liquidity management.
• Apart from the 5 sectors eligible for liquidity support under TLTRO, RBI also extended the facility to the 21 stressed sectors identified by Kamath Committee.
• Guidelines pertaining to restriction of dividend payout by scheduled banks to be also extended to systemically important NBFCs to maintain policy consistency.
• New Framework to be introduced to regulate systemically important NBFCs and subject them to bank-like capital adequacy and asset classification norms.
• Authorized Dealer (AD) banks to have full discretion in export write-off decisions without the approval of RBI in the future.
• Limit of contactless card transactions and for e-mandates for UPI to be enhanced from the current Rs2000 to Rs5000 effective Jan-21.