Our take on the RBI policy measures

Jun 04, 2021

The Reserve Bank of India (RBI’s) Monetary Policy Committee (MPC), as widely expected, 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 revive and 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 eased to 4.29% in April from 5.52% in March. Rising input costs due to a spike in raw material prices and high petrol and diesel prices could impart upward pressure. Consumer Price Index (CPI) inflation projection for FY 2022 is revised marginally to 5.1 % against 5% projected earlier, 5.2% for Q1, 5.4% in Q2, 4.7% in Q3, and 5.3% 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 made a downward revision to its projection of real GDP growth at 9.5% for FY 2022 vs 10.5% projected earlier, consisting of 18.5% in Q1 vs 26.2% projected earlier, 7.9% in Q2 vs 8.3%, 7.2% in Q3 vs 5.4%, and 6.6% in Q4 vs 6.4%.

Our Take

Secondary market G-sec acquisition programme (G-SAP 2.0) – Debt market participants were expecting RBI to continue providing support to absorb heavy G-sec supply. This was met with the RBI announcing G-SAP 2.0 for Q2 of Rs 1.2 lakh crore. This will be over and above other ongoing measures including OMOs and Operation Twist, which would continue separately and should bode well for the market while enabling stable and orderly evolution of the yield curve. Under G-SAP 1.0, purchase of Rs 40,000 crore will be conducted on June 17, of which state development loans (SDLs) worth Rs 10,000 crore will be purchased.

On-tap liquidity window for contact-intensive sectors – Rs 15,000 crore liquidity support for sectors such as hotels and restaurants, tourism, aviation ancillary services, etc. Similar to liquidity measures announced earlier, banks will be incentivized by parking surplus liquidity up to the size of the covid loan book at 40 bps higher than the reverse repo rate.

Surplus liquidity facility to SIDBI – Rs 16,000 crore liquidity facility to SIDBI should help meet the funding requirements of MSMEs. This along with the liquidity facility announced earlier should help revive the investment cycle in the MSME sector.

Enhancement of the Exposure Thresholds under Resolution Framework 2.0 – Maximum aggregate exposure for considering a resolution of COVID-19 related stress of MSMEs as well as non-MSME small businesses, and loans to individuals for business purposes increased from Rs 25 crore to Rs 50 crore.

As expected RBI maintained status quo on the policy rate and its accommodative stance, with the focus being on growth revival (as long as necessary to revive and sustain growth). During the press conference when asked about normalizing the policy stance, the governor mentioned its too early and premature to talk about that.

The need of an hour is to revive growth and the governor has been reiterating this by directing pro-active measures towards it. Also, the inflation projections for the coming quarters (within target range) do provide elbow room to focus on growth. 10-year G-sec yield saw some knee-jerk reaction – moved up 4 bps during the day, closing at 6.02%.

The G-SAP 2.0 announced today will provide further comfort to the market participants and should help address concerns around heavy G-sec supply. This along with other tools at RBI’s disposal such as OMOs and Operation Twist, 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 as it would also help corporates to borrow at low rates.

The industrial sector and services sector indicators suggest growth moderation in May amid a stronger second wave of covid. The high-frequency lead indicators show a month-on-month drop in business activity. Indian manufacturers signaled moderation in growth momentum. New orders, production volumes, and exports saw moderation from April levels with May PMI coming in at 50.8 (expansion zone) down from 55.5 in April. The services PMI was back in the contraction zone at 46.4 in May from 54 in April as new orders and output declined. The composite PMI output index at 48.1 in May is down from 55.4 reported for April. The GST e-way bills and collection numbers for May are expected to be lower than April. Auto sales and vehicle registration saw another major monthly contraction with two-wheeler down 33% and tractor sales down 25%. Q4 FY 2021 corporate results indicate companies’ ability to reduce their debt levels as private investments are halted. The weak near-term outlook on consumption demand would continue to drag private capex. This is also reflected in weak non-food credit growth numbers (up 5.7%).

The second wave of covid has again dented private consumption both in rural and urban areas. The rural areas have been affected more by the second wave as reflected by a high number of active cases and mortality rate. This will have a prolonged impact on the household earning capacity and resultant consumption demand. The recent surge in rural unemployment numbers, loans against gold (up ~86% y-o-y), and credit card outstanding (up 17%) reflects stress faced by the household sector.

Further ease in lockdown restrictions with progressing vaccination drive, and normal monsoon should help in driving demand. Any additional direct fiscal boost (MGNREGA) by the government to improve the disposable income should help in reviving consumption demand. And, as the economy opens up with fewer restrictions, it will start showing a higher multiplier effect.

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 44% y-o-y in April. Other fiscal measures announced in the Union Budget such as the PLI scheme 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. Yields at the longer end of the curve may remain range-bound supported by the RBI’s efforts to keep borrowing costs lower. The current term spread of approx. 2.3% 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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