While RBI did not cut rates on February 6, citing elevated inflation, it mentioned the scope for “future action.” As inflation eases with arrival of a new vegetable crop, expect a 25 bps repo rate cut in June
By Pranjul Bhandari & Aayushi Chaudhary
The central bank kept the policy repo rate unchanged at 5.15%, and continued its accommodative stance. The decision was unanimous across the six MPC members as well as forecasters. We, and 36 economists surveyed by Bloomberg, had expected status-quo.
In line with the sharp rise in inflation over the last few months, RBI raised its forecasts for Q4FY20 and H1FY21. However, it also expects inflation to fall sharply in Q3FY21 due to both a favourable base, and some sequential easing.
It mentioned that while one part of food inflation could ease due to a good harvest (of the kharif, the rabi, and the latest vegetable crop), another part of food inflation (milk and pulses) may be stickier. This is exactly in line with our research over the last few months.
RBI also discussed the pull and push factors impacting core prices. The telecom tariff hikes, and a rise in regulated drug prices could push inflation up. But, muted pricing power of corporates, and a correction in energy prices could offset the rise.
While RBI lowered its H1FY21 forecast, it continues to expect a gentle recovery (from 5% in FY20 to 6% in FY21).
This is likely to be supported by better rural incomes, improved credit growth, the personal income tax rate cut in the Budget, and some easing of global trade uncertainties. On the other hand, RBI remains watchful of the impact of coronavirus on economic growth. We expect the recovery in FY21 to be a shade softer than RBI—just under 6%.
2019 was a year of monetary policy easing (with 135 bps of repo rate cuts, an accommodative stance, and surplus banking sector liquidity). Early 2020 confirmed the fiscal easing (the FRBM escape clause allowing higher than budgeted fiscal deficits was triggered for both FY20 and FY21). And, now, the central bank has backed it up with some regulatory changes/easing, with a view on improving transmission, and the flow of credit (see graphic).
1. The 14-day term repo/reverse repo operation is to coincide with the CRR maintenance cycle. This is likely to push banks to borrow/lend from each other instead of RBI for liquidity management.
2. To support credit growth, RBI will conduct term repos of one-year and three-year tenors for a total amount of `1 lakh crore at the policy repo rate. Given an arbitrage opportunity, this could potentially put downward pressure on the 1-3 year G-Sec rates, which are currently trading above the 5.15% repo rate.
3. Banks giving credit to the automobile, residential housing, and MSME sectors can now deduct the amount from the Cash Reserve Ratio that has to be maintained with RBI. RBI expects this to support credit growth in sectors which it believes have a large multiplier effect on growth. This exemption, however, is time-bound, until July 2020.
4. Last year, RBI had allowed a one-time restructuring of MSME loans that were in default but ‘standard’ as on January 1, 2019. This has been extended to December 2020.
5. For commercial real estate loans, where activity has gotten delayed for reasons beyond the control of the promoter, one more year will be given before the loan is classified as default.
RBI said that it “recognises that there is policy space available for future action”. While the outlook for inflation “is highly uncertain at this juncture”, economic activity is yet to “gain traction in a more broad-based manner”.
As a new vegetable crop arrives in the market, we believe inflation will fall from ~7.5% in January to ~5% by mid-2020. While this will be above the 4% inflation target, we expect RBI to prioritise growth, and, given our expectation of a prolonged negative output gap, cut rates by a final 25bps in the June meeting, taking the repo rate to 4.9%.
Edited excerpts from HSBC Global Research’s “India RBI: Pause on rates” (February 6, 2020)
Bhandari is India Chief Economist & Chaudhary is Economist, HSBC Global Research. Views are personal