The policy review by the Monetary Policy Committee of the Reserve Bank of India held between Feb 3-5, 2021 resulted in the maintenance of status quo on Repo Rate (at 4.00%), Reverse Repo Rate (at 3.35%), and Marginal Standing Facility Rate (at 4.25%). The MPC "also decided to 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”. Both decisions of the MPC were backed by complete majority.

The policy rates and stance have remained unchanged since May-20.

Table 1: Voting on rate and stance by MPC members in Feb-21 policy review

Economic Assessment

Despite a loss of momentum in global economic recovery towards the end of 2020 on account of a surge in COVID infections in many countries, the MPC took comfort from multiple shades of recovery in domestic growth momentum.

• Most high frequency economic indicators have been showing gradual and continuous improvement in the last 6-7 months
• Flow of financial resources to the commercial sector has been picking up
• The FY22 Union Budget is expected to provide an infrastructure and healthcare led support to growth, while carrying forward critical financial sector reforms
• The commencement of the vaccination drive in many countries, including India bodes well for improving mobility and confidence in the economy

RBI accordingly, has projected FY22 GDP growth at 10.5% vis-à-vis the anticipated contraction of 7.7% in FY21. This is broadly in line with our FY22 GDP growth forecast of 11.0%.

On the inflation front, the MPC took comfort from the recent food led reduction in CPI inflation as well as some moderation in 3-month forward household inflation expectations. While the RBI expects food inflation to remain benign in the near-term on account of improvement in healthy kharif and rabi produce, core inflation is vulnerable to cost-push pressures from global commodity prices, especially crude oil and industrial raw materials. The RBI projected CPI inflation at:

• 5.2% in Q4 FY21 (revised lower from 5.8% provided earlier)
• 5.0-5.2% in H1 FY22 (revised upwards from 4.6-5.2% provided earlier)
• 4.3% in Q3 FY22

The forecast on CPI inflation also appears to be broadly in sync with our estimate of 5.0% average inflation in FY22 albeit with the aforesaid upside risks, down from an estimated average of 6.0% in FY21.

Liquidity Measures

The central bank announced three key measures on the liquidity front:

• Restoration of the earlier 100 bps relaxation in the CRR (announced in the wake of COVID relief) in two phases to 3.50% from Mar 27, 2021 and further to 4.00% from May 22, 2021. Cumulatively, this is expected to mop up about Rs 1.5 lakh Cr from the banking system.
• Extension of the On Tap Scheme for TLTRO to include NBFCs for incremental lending to the specified stressed sectors.
• Roll over of the emergency liquidity window under MSF (that currently permits liquidity by dipping into SLR up to an additional 1% of NDTL), for a period of another 6-months to Sep 30, 2021 to provide comfort to banks on liquidity management. The extension of this dispensation would assure access to funds to the extent of Rs 1.5 lakh Cr.

Regulatory and Supervision Measures

The central bank announced a set of twelve measures on easing of regulatory/ supervision structure. We believe that three of them are critical:

• The enhanced HTM limit of 22.0% of NDTL will now be extended up to Mar 31, 2023 to enable banks to participate in the increased borrowing programme of the centre and states in FY22. The HTM limits would be restored from 22% to 19.5% in a phased manner starting from the quarter ending June 30, 2023.
• To incentivize fresh credit flow to MSMEs, banks will be allowed to deduct credit disbursed to ‘New MSME borrowers’ from their NDTL for calculation of the CRR.
• To encourage retail participation in g-sec market, the central bank will now provide online access along with the facility to open gilt securities account with the RBI.

Outlook

The outcome of the Feb-21 policy review by the MPC along with the developmental measures announced by the RBI makes us believe that the central bank is likely to hold interest rates and accommodative policy stance at least through H1 FY22. However, the central bank continues to signal its mild discomfort with the extent of liquidity surplus (at Rs 6.63 Lakh Cr as of Feb 4, 2021) and hence the need for calibration through a mix of tools (variable rate reverse repo auctions and CRR restoration for the time being). Going forward, while the RBI would be replacing some of the absorbed liquidity through open market operations (gilt purchases) to anchor long term yields, it could also extend the liquidity toolkit (SDF, MSS, etc.) for calibrated absorption at the same time.

Going forward, the liquidity calibration is expected to lead to normalization in monetary policy amidst the expectation of a strong V-shaped recovery coupled with the above target inflation. At this juncture, we continue to expect the MPC to hike repo rate by 25 bps in Feb-22.