Our take on the RBI policy measures

Apr 07, 2021

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 unanimously to keep rates unchanged and continue with the accommodative stance as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward.

Retail inflation increased to 5% in February after having eased to 4.1% in January. The MPC expects a benign inflation outcome in the months ahead, driven by a moderate food inflation trajectory. Rising input costs due to a spike in raw material prices and high petrol and diesel prices could impart upward pressure. CPI inflation projection for Q4 is revised to 5% against 5.2% projected earlier, 5.2% for H1: 2021-22, 4.4% in Q3, and 5.1% in Q4, with risks broadly balanced. The evolving CPI inflation trajectory is likely to be subjected to both upside and downside pressures. On the growth front, RBI retained its projection of real GDP growth at 10.5% for FY 2021-22, consisting of 26.2% in Q1, 8.3% in Q2, 5.4% in Q3, and 6.4% in Q4.

Our Take

Some of the major measures announced today:

  • Secondary market G-sec acquisition programme (G-SAP 1.0) – debt market participants were expecting RBI to draw an OMO purchase calendar which would help them gain clarity on absorbing heavy G-sec supply. RBI went a step ahead by announcing G-SAP of Rs 1 lakh crore for Q1 FY2021-22 with the first purchase of Rs 25,000 crore to be conducted on April 15, 2021. This will be over and above other ongoing measures including OMOs and Operation Twist, which would continue separately This should bode well for the market while enabling stable and orderly evolution of the yield curve.
  • SLR holding in 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 2022, which in February 2021 got extended to 31st March 2023. This is expected help banks to absorb the heavy G-sec supply and plan their investments in SLR securities as the extension of HTM dispensation opens up space for investments of more than Rs 4 lakh crore.
  • Extension of the TLTRO on tap scheme – RBI had earlier announced funds from banks under the TLTRO scheme to be extended to NBFCs for incremental lending to stressed sectors. This is now extended till September 30, 2021 and should help banks/NBFCs avail liquidity to lend to the stressed sectors and disseminate credit flow.
  • Liquidity facility for All India Financial Institutions (AIFIs) – extend fresh support of Rs 50,000 crore to NABARD, NHB, and SIDBI for new lending in FY 2021-22. This will help improve credit flow in the agriculture, housing, and MSME sectors.

As expected RBI maintained status quo on the policy rate and its accommodative stance. 10-year G-sec yield saw a volatile trade opening at 6.11%, moved up to 6.19% during the early part of the governor’s address, and later fell to 6.05% with the announcement of G-SAP – ultimately closing at 6.08%.

Lately, the RBI has repeatedly spoken of the orderly evolution of the yield curve. Today as well the governor in his statement said, “let me unequivocally state that the Reserve Bank’s endeavor is to ensure orderly evolution of the yield curve, governed by fundamentals as distinct from any specific level thereof. Our objective is to eschew volatility in the G-sec market in view of its central role in the pricing of other financial market instruments across the term structure and issuers, both in the .public and private sectors”.

The G-SAP announced today will provide a lot of comfort to the market participants and should help address concerns around heavy G-sec supply. OMOs, Operation Twist and G-SAP along with any development on the participation of retail investors (announced in the Feb policy) and inclusion in the global bond index should provide a buffer to absorb supply pressures, if any, later in the year, and keep yields under check. RBI would endeavor to keep the borrowing rates (weighted average yield) low. It would also help corporates to borrow at low rates.

The guidance for the accommodative stance is a bit different in this policy as compared to the last couple of them. The MPC removed the time-bound guidance for maintaining its policy stance which in earlier policy documents read as– ‘…at least during the current financial year and into the next financial year’. This could be on account of the renewed uncertainty around the economic impact of the second Covid wave. In our view, this change shouldn’t have a material impact on RBI’s commitment to supporting the economy and markets. During the course of the pandemic, the RBI has established credibility for the actions that they have taken and the revised guidance should continue to provide comfort to the markets.

Ongoing Variable Rate Reverse Repos (VRRR) as a part of RBI’s liquidity management operations hints towards reversal or normalization of the liquidity situation, which is broadly expected to happen but, RBI stands committed to maintaining liquidity at a comfortable level. It would reduce the current steepness and term premia or maturity spreads.

Other EM central bank peers (Brazil and Russia) have started to raise interest rates amid fear of capital outflows and the resultant pressure on their currencies and inflation, with a rise in the US Treasury yields. This poses a risk even for India and would be interesting to see how the RBI can intervene to stabilize extreme market outcomes. On the policy rate front, the probability of prolonged pause has increased, although rising global yields don’t eradicate a possibility of a rate hike later in the year.

The industrial sector and services sector indicators suggest progress towards normalization. The high-frequency indicators signal a recovery in the urban and rural consumption demand, business activity, and energy consumption – supported by ongoing vaccination drive. Indian manufacturers signaled growth in new orders, production volumes, and exports although saw moderation from February levels with March PMI coming in at 55.4 (expansion zone). The services PMI for March at 54.6 also shows a positive momentum in growth recovery. The composite PMI output index at 56 in March is down from 57.3 reported for February. The recent monthly GST collection number (Rs 1.24 lakh crore) which is at an all-time high is encouraging. The capacity utilisation in the manufacturing sector improved to 66.6% in Q3, higher than Q2, although lower than the long-term average of 74%. The recent pick-up in consumption demand looks resilient and if it sustains should instil confidence in banks to lend and manufacturers to improve private capex. Non-food credit across different sectors is picking up but banks holding of excess SLR increased to 11.4% of NDTL, reflecting resistance in credit offtake. The evolving covid-19 situation with a surge in the second wave and few states announcing partial lockdown pose as a risk to the revival in the economic activity.

The reform measures announced earlier such as ECLGS is improving credit flow to the MSME sector with credit to medium industries registering a growth of 21% y-o-y in February. As of February 28, 2021, the utilisation under ECLGS stood at 82%. Other fiscal measures announced in the Union Budget such as the PLI scheme, covering 13 sectors with a commitment of government support amounting to nearly Rs 1.97 lakh crore is attracting investments and should help in improving exports. Clubbed with higher capital expenditure by the government bodes well for the investment cycle.

Short-term yields may see some uptick with the normalization of the banking system liquidity. With the last few days of yield movement at the longer end, yields may remain range-bound supported by the RBI’s efforts to keep borrowing costs lower. The current term spread of approx. 2.5% in the medium-long term segment i.e. 5-10 years maturity 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 at sub 1% and negative, respectively.

In this unique economic situation, we are actively reviewing our views across asset classes and portfolio positioning.

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