India went into the third monetary policy of FY21 with a lot of rate cut hopes but conscious of the reality that inflation is well above the RBI comfort zone. The August policy is the first policy in this fiscal year that will be announced on the scheduled date. The April policy was announced at the end of March and the June policy was announced at the end of May.
Of course, in both these policies, the focus was to stimulate growth. As a result, the RBI cut rates by 75 bps and 40 bps in the last two policies. With repo rates already at an all-time low of 4% and reverse repo rates at 3.35%, one view was that the RBI may go easy on rate cuts. Inflation at 6.1% could be another dampener as it is now above the upper limit prescribed by the RBI. It is in this background that RBI announced the monetary policy on 06 August.
Highlights of the Monetary Policy, Aug-20
There was not much of a surprise in the actual policy announcements.
• The Monetary Policy Committee (MPC) opted to maintain the status quo on repo rates at 4.00% and the reverse repo rate at 3.35%.
• As a result, the bank rate and the MSF rate also remain static at the level of 4.25% with its 25 bps spread over the repo rate.
• MPC has decided to retain the accommodative stance of the monetary policy hinting that RBI would be willing for further rate cuts to spur growth.
• The decision to hold status quo on rates was unanimous with all the six members of the MPC voting to hold the repo rates at 4%.
• With the August policy announcement, the MPC formed in 2016 has completed 4 years of existence and has presented 24 monetary policies in all.
How the growth outlook panned out?
The MPC has stated that the green shoots of recovery seen post-May could not be sustained due to the pandemic impact relapsing in July. This applied further pressure on growth as is visible from the recent PMI, IIP and core sector figures. For example, the core sector growth has remained in contraction mode for the fourth month in succession.
MPC has also pointed out that while the core sector remains under pressure, the PMI manufacturing and services have gotten back above 50 hintings that growth expansion may finally be happening. MPC has also pointed out that the Indian economy was likely to see GDP contraction in the first half of FY21 and despite the recovery in H2, the full fiscal GDP could contract by 4-5% in FY21.
Improved transmission gives RBI the luxury to wait
In its Financial Stability Report, the RBI had noted that the financial transmission was improving, especially after the massive liquidity infusion and the shift to external benchmark based pricing of loans. Out of the 115 bps of a rate cut by the RBI in April and June, nearly 88 bps had already been passed on. Also, the combination of liquidity and Operation Twist meant that the average spread over AA+ rate bonds had contracted by 200 bps, reducing the cost of funds substantially. With repo rates at a multi-decadal low of 4%, MPC saw merit in waiting for the transmission to play a bigger role in yield reduction.
Inflation remains the worry, although monsoons are encouraging
Another factor that triggered the status quo on repo rates was the spike in inflation. CPI inflation at 6.09% is above the outer comfort limit of RBI. Hence the MPC has given itself time till October for inflation to moderate. Cropping in the 2020 Kharif season has been 13.9% higher and that promises a bumper crop this year. That combined with a reduction in supply chain bottlenecks is expected to lead to lower inflation making a stronger case for a rate cut in October; when the MPC may even consider 50 bps.
Going beyond the macros on monetary policy
Like in the previous policies, the RBI has stretched itself beyond the normal policy announcements. There is no clarity on the EMI moratorium extension. Here are some non-monetary takeaways.
• The liquidity facility will be expanded by Rs.10,000 crore to be equally divided between lending to housing and agricultural sectors.
• RBI has extended the window where businesses can get their loans restructured on a case-by-case basis without impacting their credit standing or ceding ownership.
• To enable families to better leverage their gold assets, the maximum loan to value (LTV) ratio for gold loans has been enhanced from 75% to 90% till Mar-21.
• Reduction in capital allocation for bank investment in debt funds / ETFs to put them at par with direct debt investments. This will reduce the bank’s capital allocations.
The MPC has given a monetary break till there is greater clarity on the inflation front. The October policy could provide a clearer picture of the RBI’s monetary stance.