Overall, we expect the evolving growth inflation dynamics to open space for more cuts during 2020-21, potentially starting in December.
The RBI now expect GDP to contract 9.5% or more in 2020-21, with further downside risks.
By Siddhartha Sanyal
The policy communication was emphatic to convey the RBI’s commitment to support growth recovery. The MPC’s hands were virtually tied as regards the policy rates given the prevalent CPI prints. Unsurprisingly, the committee voted unanimously for a status quo on rates. However, the guidance to “continue with the accommodative stance of monetary policy as long as necessary – at least during the current financial year and into the next year – to revive growth on a durable basis” came in as an unusually strong and explicit commitment to support growth recovery; five of the six MPC members supported this stance.
The next MPC move is a cut; potentially in 2020 itself
The MPC rightly decided to look through the current inflation hump which it believes to be transient – a view we completely agree with! Indeed, surge in CPI of late largely reflected supply disruptions, and not demand overheating. The benign wholesale price inflation (WPI) readings also support that view. Even the high core inflation optics reflects large contributions from items like precious metals. Overall, CPI inflation is set to head sub-4% during Q4 2020-21.
The RBI now expect GDP to contract 9.5% or more in 2020-21, with further downside risks. We indeed see downside risks to the RBI’s GDP forecasts, including for the forecast of 9.8% contraction during the July-September quarter. Overall, we expect the evolving growth inflation dynamics to open space for more cuts during 2020-21, potentially starting in December. While the early-summer rate cuts targeted immediate cushion, subsequent cuts will target maximum effectiveness to boost recovery in activities.
Strong support for bonds
The RBI’s decision today to increase the quantum of weekly OMOs and to conduct OMOs on state government bonds should provide meaningful comfort to the gilt market. These measures, along with the extension of HTM till March 2022, should help easing concerns about illiquidity and market’s absorptive capacity for government borrowing in the coming months. However, given the potentially rising government borrowing, continued RBI support might be needed to keep bond yields anchored.
One feels that policymakers may consider (a) elongating the maturity profile of the government’s liabilities, especially given the current low interest rates, and (b) issuing larger quantum of securities in the benchmark 10-year bucket to ensure better liquidity in this segment, apart from (c) stepping up overall quantum of OMO purchase during H2 2020-21. In this context, while the RBI refrained from announcing an OMO calendar, the mention of conducting “market operations in the form of outright and special open market operations” should be comforting.
Regulatory changes encouraging
Introduction of the “on-tap” TLTRO should provide financial intermediaries meaningful flexibility as regards quantum and timing of their borrowing through this window. One feels TLTROs can play a major role in supporting near-term economic activities. Steps such as (a) rationalision of risk weights on housing loans and (b) expanding the ambit of co-origination model through inclusion of all NBFCs, including HFCs, are also welcome moves.
Going ahead, we foresee continued support from policymakers towards revival of economic activities, including in the lower end of the economic pyramid such as MSMEs, affordable housing, and microfinance. Some of these segments have started turning a corner, and with reasonable policy support, can attain further resilience and growth. That will not only offer immediate cushion to a large number of relatively less privileged people, but will also reduce the need for further fiscal support for these segments over the medium term.
(Author is chief economist and head of research in Bandhan Bank. Views are personal. The author thanks Sourav Sarkar and Rahul Singh for their assistance)