The bi-monthly review of Monetary Policy Committee of the Reserve Bank of India (RBI) held between Aug 4-6, 2021, expectedly witnessed a status quo for the seventh time in a row on policy rates with 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 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”.

While the decision on rates was completely unanimous decision backed by a 6-0 voting outturn, the one on the accommodative stance saw a lone dissent with 5-1 voting outturn.

Economic Assessment

The central bank retained its forecast for FY22 GDP growth at 9.5% amidst ongoing gradual unlock by most states and the likelihood of south-west monsoon being normal (cumulative rainfall between Jun 1 and Aug 6 stood 3% lower vis-à-vis the long period average). While the former would help to restore supply side disruptions from the second wave, the later would support another healthy kharif crop, and thereby rural demand.

Meanwhile urban demand is expected to find support from revival in contact intensive sectors, the recently announced DA/DR hike for central government employees, and a relatively faster progress in vaccination.

Further, buoyant demand for exports along with the expected pick-up in public spending would provide impetus to overall aggregate demand, including investments.

RBI’s FY22 growth projection is marginally lower vis-a-vis our own estimate of 10.0% with some downside risk.

• Elevated input prices would dampen the value add at a sectoral level
• Tapering of ongoing quantitative easing programmes by systemically important central banks could increase volatility in financial markets
• Risk of another surge in Covid infection is gradually rising in select states

On inflation front, the RBI revised upwards its FY22 average CPI inflation forecast by 60 bps to 5.7%, close to our estimate of 5.5%.

• In RBI’s assessment, inflation continues to remain a function of supply disruptions and higher commodity prices.
• The anticipated revival in kharif sowing is expected to play a prominent role in curbing food price pressures, and thereby overall inflation.
• Supply side interventions by the government (in case of edible oils and pulses) are likely to yield some favorable outcome in the coming months.

Liquidity and Credit Measures

The central bank announced the following key measures to manage liquidity and facilitate credit growth, with a focus to ensure more equitable access to liquidity across sectors.

• The size of the variable rate reverse repo (VRRR) auctions is proposed to be increased in a phased manner to Rs 4 Lakh Cr by end Sep-21 from Rs 2 Lakh Cr at the current point.
• Announced two g-sec purchase auctions worth Rs 25,000 Cr each on Aug 12 and Aug 26, 2021 under G-SAP 2.0 to enable a stable and orderly evolution of the yield curve.
• Extended the on-tap TLTRO scheme by a period of 3-months, until Dec 31, 2021 to support the nascent and fragile economic recovery.
• Extended the special liquidity dispensation of 1% of NDTL under the MSF window by 3-months, until Dec 31, 2021. This dispensation provides increased access to funds to the extent of Rs 1.62 lakh Cr and qualifies as high-quality liquid assets for banks’ LCR maintenance.
• Permitted banks to extend export credit in foreign currency using any widely accepted alternative reference rate (ARR) in lieu of phasing out of LIBOR. Further, the central bank also allowed banks to treat the change in reference rate from LIBOR to an ARR as a "force majeure” event for foreign currency derivative contracts, thereby obviating the need for restructuring. This is likely to provide relief to the banking sector as well as their counter parties.
• Extended the deadline for achieving operational performance thresholds (with respect to Total Debt to EBIDTA Ratio, Current Ratio, Debt Service Coverage Ratio and Average Debt Service Coverage Ratio) under Resolution Framework 1.0 for Covid related stress to Oct 1, 2022 from Mar 31, 2022 currently. This will provide relief to borrowers in stressed sectors who have faced operational challenges because of the severe second wave.

Outlook on monetary policy

The Governor in the post policy press conference stated that the RBI continues to remain in "whatever it takes” mode for providing support for nurturing nascent growth impulses. This highlights the unambiguous policy desire to backstop growth till Covid related economic and financial uncertainties remain. Greater clarity on durability of recovery is likely to emerge with the progress of vaccination and scope/severity of any further wave of Covid infection.

While future waves of Covid cannot be ruled out basis ongoing mutations, the spread in vaccination could hopefully taper the severity. India has been able to partially vaccinate nearly 29.6% of its population (as of Aug 8, 2021), this is likely to get extended to at least 60%-70% of the population before the end of Dec-21. We believe this would play a critical role in providing confidence to the RBI on the durability of economic recovery, and thereby pave the way for gradually reprioritizing the inflation objective.

In our opinion, the policy review of Aug-21 has a subtle shade of policy normalization in the form of the scale up of the VRRR auctions for temporary deployment of excess liquidity since it can lead to some firming of short term rates and realignment of the yield curve. However, we continue to expect the central bank to start normalization of the policy rates by increasing reverse repo rate from 3.35% currently to 3.75% by end of Q3FY22 or during Q4FY22, followed by a 25 bps hike in the repo rate to 4.25% in Q1FY23.

Annexure

Chart 1: Revised GDP and CPI inflation estimates from RBI