In keeping the repo rate unchanged and maintaining an accommodative stance, Reserve Bank of India Governor Shaktikanta Das reflected a dovish stance. The central bank signalled its intent to keep rates low and look through the inflation overhang to promote growth. The policy announcement by the monetary policy committee (MPC) seems to aim at helping managing the yield curve to facilitate borrowings.
With the backdrop of GDP growth at -23.9 percent in Q1FY21 and inflation at a high of 6.69 percent in August 2020, the MPC expects the FY21 GDP to decline by 9.5 percent.
It anticipates a positive turn for the economy only by Q4FY21, with a caveat of a downside risk with a second wave of COVID-19. The economy is likely to face another downtrend from inflationary risks. The September 2020 print is expected to be closer to 7 percent, with a possible easing seen only after November 2020.
After a sharp fall in growth in Q1FY21, a few factors are pointing to a slow but steady economic recovery. Some high-frequency indicators are showing a smart uptick, major reservoirs are filled at healthy levels, kharif crop yield has seen excellent growth and food grain production is expected to touch a record high.
The PMI for Manufacturing crossed the February 2020 levels of 54.5 to reach 56.8 in September 2020. The PMI for Services recorded a 19 percent rise in September from August. These positive economic sentiments were also amplified by key factors suchas population mobility, the return of migrant labourers, increasing traffic intensity, reduction in CMIE unemployment data and opening of offices.
To aid and sustain this revival, various measures have been announced by the MPC while promising to maintain an accommodative stance for the current financial year and into the next year.
The MPC has adopted a multi-pronged approach by providing liquidity, extending the period of the liquidity window, maintaining rates and reducing the risk weights to certain types of lending (MSME, housing and state government borrowings). However, easy availability and low cost of credit can have its own long-term risk.
The MPC has provided for an on-tap targeted LTRO's of Rs 1 lakh crore for up to three years at a floating rate linked to the policy repo rate. While this is available up to March 31, 2021, they reserve the right to enhance the amount or the time frame.
On the open market operations (OMO) front, the MPC made two major announcements–it doubled the weekly OMO size to Rs 20,000 crore and introduced OMOs for State Development Loans (SDL). These steps resulted in yields falling across the curve and in lower spreads between G-Sec and SDLs. It also paves the way for the government to borrow at lower rates for the rest of the borrowing calendar. During H1FY21, it borrowed at 5.82 percent and with the H2FY21 borrowing calendar being long-tenor heavy, the RBI was not comfortable with 10-year G-Sec yield at over 6 percent. The yield on the 10-year g-sec fell by 10 bps to 5.93 percent post the policy announcement.
The RBI enhanced the time limit for holding 22 percent of SLR as Hold to Maturity by a year to March 2022, thereby giving banks time to plan their HTM portfolios and allow more room to absorb more G-Secs.
To enhance credit flows to MSME sector, the single-party exposure limit for retail portfolio has been increased from Rs 5 crore to Rs 7.5 crore. However, the lack of credit offtake and the general caution to lend to this segment could hamper the spirit of this measure.
A key measure intended to benefit the housing sector and probably more for the higher-ticket homes is the removal of the “size of loan” parameter while undertaking risk assessment. Only the loan-to-value ratio would be considered for assessing the requirement of risk capital for lenders for new home loans. With a view to facilitate payments in real time, the RTGS facility will be available 24X7 from December 2020.
With no rate cuts announced, the MPC has now built up room for possible rate cuts, depending on the demand, supply and inflation dynamics, after the festival season.