The RBI’s 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%. All the 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 going forward.
Retail inflation spiked up in October (7.6%), driven by a rise in food inflation (10.16%) amid supply shocks. CPI inflation has been higher than the upper band of RBI’s target over the last few months. The MPC stated that the CPI inflation is likely to remain elevated and it constrains the MPC at the moment from using the space available to act in support of growth. Inflation is expected to return to the target range of 4% +/-2% with supply disruptions likely to mitigate and positive base effect.
CPI inflation is projected at 6.8% for Q3 2020-21, 5.8% for Q4, and 4.6% - 5.2% for H1: 2021-22 with risks broadly balanced. Interestingly, in today’s Monetary Policy document the MPC didn’t use the following statement mentioned in October’s statement - “The MPC believes that the current levels of inflation are transient, and they would look through them and prioritize the revival of the economy”. This clearly indicates the MPC’s concerns around the persistence of marginally higher levels of inflation at least in the near term.
On the growth front, RBI revised its GDP growth expectations and now projects real GDP growth in 2020-21 to be negative 7.5% from the negative 9.5% mentioned earlier with risks broadly balanced. Real GDP growth for H1 2021-22 is projected at 21.9% to 6.5% amid a lower 2020-21 base. The market estimates indicate a 7% - 9% contraction in GDP for FY2021.
Our Take
As expected RBI maintained status quo on the policy rate and its accommodative stance. With CPI inflation consistently above the upper bank of RBI’s target range and expected to remain elevated, a status quo was broadly expected. After a back-to-back rise in CPI inflation and not so favorable outlook, it may not be prudent to call inflation levels transient and look-through them. Supply-side pressures continue to linger and there’s a risk that the excessive surplus liquidity in the banking system may fuel inflation in the coming months. This coupled with an expanding fisc driving inflationary pressures may make it difficult to bring down inflation considerably with growth on the other hand witnessing some sort of a revival.
Q2 FY21 real GDP contracted by 7.5% vs a negative growth of 23.9% in Q1FY21. Private consumption and investments saw improvement vs Q1 with demand coming back and resumption of projects stalled by Covid-19. Although, government expenditure saw a contraction of 22% in Q2 vs 16.4% growth in Q1.
The high-frequency indicators signal a decent recovery in the urban and rural consumption demand, business activity, and energy consumption. How much of it can be sustained in the coming months post drying up of pent-up demand needs to be watched closely to make a better assessment of the economic growth revival. Auto companies reported high passenger vehicle sales in the last three months, amid unlocking of pent-up demand and preference for personal mobility. 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 growth in new orders and production volumes with November PMI coming in at 56.3 (expansion zone) although lower than 58.9 reported in October. The services PMI for November at 53.7 also shows a positive momentum in growth recovery. The composite PMI output index at 56.3 in November is down from 58.0 reported for October amid moderating growth in private sector output. GST collections improved in recent months and are close to the pre-covid levels.
Since the onset of Covid in March’20, the RBI 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 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 subdued business and consumer sentiments. Banks are gradually opening up to lend to the businesses with some improvement in the growth prospects. Credit growth remains low at 5.5% y-o-y with agriculture at 7.4% and industry at -1.7%. Whereas, credit growth for services at 9.5% and personal loans at 9.3% continue to perform well. Extension of the on-tap TLTRO to the 26 stressed sectors coupled with the ECLGS 2.0 scheme announced by the government should ease out the availability of credit. Given the strong response seen by the ECLGS scheme, (~INR 2 lakh crores sanctioned against the overall corpus of INR 3 lakh crores) government may consider increasing the assigned corpus.
Disruption in the labor market both organized and unorganized sectors due to Covid-19 needs to see a significant improvement for the consumption demand to normalize. The ease of doing business needs to improve further and infrastructure bottlenecks need to be removed to compete effectively with other Asian manufacturers/exporters. The recent measures – land, labour & Agri reforms, Production Linked Incentive scheme (PLIs), etc. - announced by the government are steps in the right direction and should bode well for the growth recovery. Investment in factories and other fixed assets (supported by strong FDI inflows) needs to pick up meaningfully.
10-year benchmark G-sec yield fell marginally around 3 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. Short-term yields continue to be at lower levels amid excessive surplus liquidity. The long end of the curve still faces the risk of worsening fiscal conditions. Although yields have been range-bound supported by the RBI’s efforts to keep borrowing costs lower. With short-term rates at low levels, the current term spread in the medium- long term segment i.e. 5-10 years maturity (~2.5%) is above the long-term historical average of 1.5% – 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.
