The RBI’s newly appointed Monetary Policy Committee (MPC), decided to keep the policy repo rate unchanged at 4%. Consequently, the reverse repo rate stands unchanged at 3.35%, and the marginal standing facility (MSF) rate and the Bank Rate at 4.25%. Members of the MPC voted to keep rates unchanged and continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range of 4% +/- 2% going forward.
Retail inflation eased slightly in August as food inflation cooled but remained above the upper end of the RBI’s medium-term target for the fifth straight month. Retail inflation stood at 6.69% Y-o-Y, lower than the 6.73% in July. CPI inflation has been higher than the upper band of the RBI’s target for the last few months. RBI expects CPI inflation to moderate as supply disruptions are likely to mitigate with easing lockdowns, favorable food inflation outlook, and positive base effect. The MPC believes that the current levels of inflation are transient, and they would look through them and prioritize the revival of the economy. CPI inflation is projected at 6.8% for Q2 2020-21, 5.4% - 5.5% for H2: 2020-21 and 4.3% for Q1 2021-22 with risks broadly balanced. On the growth front, RBI expects real GDP growth in 2020-21 to be negative 9.5% with risks tilted to the downside. Real GDP growth for Q1 2021-22 is projected at 20.6% amid a lower 2020-21 base. The market estimates indicate a 7% - 10% contraction in GDP for FY2021.
The MPC also announced an additional set of unconventional measures to enhance liquidity support and improve the flow of credit.
1. On tap TLTRO – RBI to conduct on tap Targeted Long-Term Repo Operations (TLTRO) with tenors of up to 3 years for a total amount of up to Rs 100,000 crore at a floating rate linked to the policy rate. This move will help banks avail liquidity to lend to the impacted sectors and improve credit flow. Banks are allowed to classify these investments as HTM in excess of existing limits.
2. SLR holdings in the HTM category – RBI had earlier increased limits under the Held To Maturity (HTM) category from 19.5% to 22% of NDTL up to 31st March 2021, which is now extended to 31st March 2022. This will help banks to absorb the G-sec supply and plan their investments in SLR securities.
3. OMO purchase of Rs 20,000 crore – RBI remains committed to support the market and helps in absorbing heavy G-sec supply along with keeping the borrowing costs low.
4. OMOs in State Development Loans (SDLs) – This is a new measure, never announced before. RBI will conduct OMOs in SDL securities in this fiscal year. This move will improve market sentiment as it will help in absorbing the excessive SDL supply. Also, states may consider financing their deficit by additional market borrowing. This will also help in keeping the states borrowing costs low.
5. Measures for the real estate sector – RBI decided, as a countercyclical measure, to rationalise the risk weights of individual housing loans by linking them only with LTV ratios for all new housing loans sanctioned up to March 31, 2022. Such loans shall attract a risk weight of 35% where LTV is less than or equal to 80%, and a risk weight of 50% where LTV is more than 80% but less than or equal to 90%. This measure is expected to give a fillip to bank lending to the real estate sector and probably reduce home loan rates as the capital requirement for Banks & probably HFCs would reduce thereby reducing the cost of funds.
Our Take
As expected RBI maintained the status quo on the policy rate and the stance. With CPI inflation currently above the upper bank of RBI’s target range and expected to remain elevated in the over the next few months, a status quo was broadly expected. The RBI’s focus is on reviving the economy while keeping inflation in check. With supply shocks expected to mitigate in the coming months, inflation is projected to move close to the targeted range. This may give RBI some additional comfort during the December MPC meeting.
The measures for the bond market outlined above are significant and would help address concerns of bond market participants on the widening fiscal deficit and help reduce term spreads across the medium to the longer end of the yield curve for government securities and other bonds. The Governor in his statement mentioned that the RBI acknowledges the increasing borrowing requirements of the government due to the Covid linked economic slowdown and reiterated its commitment to support the market with liquidity, OMOs, and other measures as required to avoid an increase in borrowing rates which would be detrimental to the economy.
The RBI in the last few months has taken both conventional and unconventional measures to support the economy, provide market stability, improve credit flow, and ease financial stress for corporates and banks. The measures have helped to bring down the borrowing costs for corporates and individuals. Banks, to a large extent, have been able to transmit lower rates – supported by significant surplus liquidity in the banking system. However, monetary transmission and surplus banking system liquidity has so far not resulted in higher credit growth, mainly due to weak business and consumer sentiments amid an uncertain market environment. Banks are still reluctant to lend to businesses amid a bleak economic outlook. This can be substantiated with banks G-sec holding of ~24% against the required SLR of 18%. Credit growth remains low at 6% y-o-y with agriculture at 4.9% and industry at 0.5%. Whereas, services at 8.6% and personal loans at 10.6% continue to perform well.
Some of the high-frequency lead indicators suggest modest growth improvement over the last couple of months as the lockdown restrictions were eased. Auto companies reported high passenger vehicle sales in Q3, particularly in September amid unlocking of pent-up demand and dealers building up the inventory ahead of the festive season. Tractor sales and two-wheeler sales also increased significantly in the last couple of months – early signs of rural demand pick-up. Indian manufacturers signaled a much stronger rebound in new orders and production volumes with September PMI coming in at 56.8 (expansion zone) against 52 reported in August. The services PMI for September at 49.8 is up from 41.8 reported for August, indicates a broadly stable output across the sector. The composite PMI output index at 54.6 in September is up from 46 reported for August backed by growth recovery across sectors. GST collections improved in September and are close to the pre-covid levels. E-way bills saw a y-o-y growth of ~9% in September. Retail spending has seen some tick up ahead of the festive season, and if sustained in the following months, it may show an overall improvement in the consumption expenditure.
Although lockdown restrictions have been lifted largely, the severely impacted sectors such as hospitality, travel & leisure need some direct fiscal support to revive. As per media reports, the government is working towards another fiscal package and markets would expect it to have a direct impact on these sectors along with measures to boost employment and household income rather than providing credit as was the case with the Atma Nirbhar Bharat package.
On the fiscal front, the government kept its borrowing program for the current fiscal year unchanged at Rs 12 trillion which was last revised in May. The risk of not meeting revenue targets continue to persist. This along with no change in the government’s borrowing plan for the second half of the fiscal year hints towards a cut in government expenditure for the rest of the fiscal year. With growth contraction in private consumption and investments, any cut in the government expenditure would further dampen the weak growth prospects. Although a possibility of additional borrowing which could be announced in December or January can not be ruled out.
10-year benchmark G-sec yield fell around 8 bps after the policy announcement. RBI continues to provide support to the market by conducting regular OMO purchases of slightly longer-dated government securities. Global central banks have vowed to keep interest rates low or close to zero to support their ailing economies and are focusing on controlling the yield curve. RBI is also working on a similar path, and this helps to keep the overall borrowing costs low for the government, corporates, and individuals.
Over the last year, the yield curve has seen a significant downward shift and steepening with surplus liquidity and policy rate cuts largely getting transmitted at the short end. The long end of the curve still faces the risk of worsening fiscal conditions. RBI’s targeted approach with OMO purchases has also led to yields falling at the longer end thereby bringing down the borrowing costs. With short-term rates coming off massively with excessive liquidity, the current term spread in the medium-long term segment i.e. 5-10 years maturity (2.5% - 3.0%) is significantly above the long-term historical average of 1.42% – improving its relative attractiveness over short-term debt and cash where the real rates are negative.
In this unique economic situation, we are actively reviewing our views across asset classes and portfolio positioning.
