A rate-cut may not be likely before December 2020, even though the MPC has signalled an accommodative stance.
The MPC was certainly not faced with an easy choice as it met in August 2020, with above-target inflation amidst a faltering economy. The outlook for both is hazy, given the continuing Covid-19 spikes necessitating extensions of localised lockdowns.
In this complicated context, the MPC kept the policy rates unchanged in its August 2020 review, in a unanimous decision, in line with its primary mandate of ensuring CPI-inflation within a band of 4% +/-2%. This contrasted with the expectation of a front-loaded rate-cut despite the high inflation prints, in a bid to signal some support to the economy.
However, the MPC stated that supporting a recovery assumes primacy in the conduct of monetary policy and, therefore, it retained the stance as accommodative. This signals that the door remains open for further rate reduction. However, the extent of the same is likely to be modest, given the MPC’s emphasis on using the available policy space judiciously.
Along with the CPI inflation data for June 2020 (6.1%), the CSO had released the imputed back prints for the lockdown months of April 2020 (7.2%) and May 2020 (6.3%). This had revealed that the year-on-year (y-o-y) CPI inflation unnervingly remained above the upper band of the MPC’s medium-term inflation target range throughout Q1 FY21. The MPC has now indicated that it will treat the imputed data for April-May 2020 as a break in the series. Nevertheless, the CPI inflation of 6.1% in June 2020 was both higher than the level in March 2020 (5.8%), as well as the target range of 2-6%.
Looking ahead, the MPC revealed discomfort on a multitude of inflation risks, related to supply-chain disruptions, high vegetable prices, stickiness in protein prices, increased taxes on fuels, rising asset prices and volatility in financial markets. Accordingly, it expects inflation to remain elevated in Q2 FY21, and then record a base-effect-led moderation in H2 FY21. Along similar lines, households’ three months-ahead inflation expectations remained above their one year-ahead expectations, in the latest survey conducted by RBI, indicating their anticipation of a decline in inflation over the course of the year.
In terms of the real sector, the MPC highlighted that the prospects for agriculture have strengthened with healthy kharif sowing, rainfall and reservoir levels, and concluded that a recovery in the rural sector is underway. Further, it indicated that firms are hopeful of a gradual pickup in domestic demand.
Worryingly, however, the results of RBI’s consumer confidence survey became more pessimistic in July 2020 relative to the May 2020 round. Additionally, external demand is highly likely to remain muted amid the ongoing global economic uncertainty. Therefore, the MPC expects a contraction in real GDP in FY21; our own projection suggests a sharp 9.5% y-o-y de-growth in the current fiscal.
While the MPC was constrained by inflation, RBI unveiled a slew of measures to support the economy, including restructuring for individual and corporate loans, increasing the LTV on gold loans, additional liquidity to NABARD and NHB, and reduction in risk weights for banks’ investments in debt mutual funds. The biggest announcement is the proposed restructuring of individual and corporate loans. This is expected to provide some succour to borrowers, some of whom have faced severe cash-flow challenges during the lockdown. Moreover, this will offer some near-term relief to Banks, by reducing their reported NPAs and capital requirements.
The moratorium that had first been permitted from March-May 2020, had been extended earlier by the RBI up to August 2020. Loans under moratorium stood at as much as half of the entire loan book at the system level, as on April 30, 2020. However, almost all the lenders have reported a decline in the same during the second phase of the moratorium.
Based on our expectation of a further reduction in the loan book in the coming months, and the proposals to have necessary safeguards around the restructuring, we expect the same to be restricted to a modest 5-8% of the overall loans at the system level.
As we move ahead, the high-frequency indicators of the real sector will eke out a gradual recovery from the lows displayed in Q1 FY21, characterised by unevenness across sectors and regions. The y-o-y CPI inflation is likely to harden in July 2020, reverse course but remain above 4% till October 2020, and then soften in H2 FY21 aided by a favourable base effect. Accordingly, the MPC may well remain in a wait-and-watch mode in its next scheduled policy meeting in October 2020, with a final rate cut likely to be delayed to December 2020.