Worst is over, says RBI governor while predicting three-speed recovery; rates left unchanged

It was a warm up meeting for the RBI's freshly-constituted Monetary Policy Committee (MPC). The MPC unanimously voted to keep benchmark rates unchanged in its first meeting, which came days after the committee broke its vow with inflation breaching the 6% upper tolerance band for three quarters in a row. Repo rate now stands at 4% and reverse repo at 3.35%. 

The committee maintained an accommodative stance, which is to communicate by thoughts alone, while actual rate cuts will come in due time, which policy watchers believe won't be until next year. 

The big reveal in Friday's policy review is GDP estimate with RBI gaining a clear read on the economy since the pandemic began in March. 

In FY21, real GDP may contract 9.5%, but Governor Shaktikanta Das assured that the worst was over. Subject to avoiding a second wave of infections, we can shrug off the 'deathly grip of the virus' and as we shift focus from containment to revival, growth will likely enter a positive realm starting 2021. 
 
In Q2, growth may have shrunk by 9.8%, which is better than the 23.9% contraction seen in Q1. Though monthly high frequency indicators are cranking out positive data, Q3 will still see a contraction of 5.6% and as recovery becomes broad-based, Q4 will see a modest growth of 0.5%. 

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If everything goes by the script, real GDP growth in Q1 of FY22 will be at a healthy 20.6%.

Notwithstanding the overwhelming evidence pointing to recovery, the question on the pace of recovery remains. Will it be V, U, W, L or K? Das believes, it could be a 3-speed recovery. First layer includes sectors opening up early like agriculture and allied activities, FMCG goods and auto to an extent. Second includes those where activity is normalising gradually followed by third comprising 'slog overs,' or those entities severely affected by social distancing norms. 

With agriculture outlook remaining robust, it's expected to boost rural demand and consumption may go up in Q3. Manufacturing and some services categories recovered in Q2, and capacity utilisation is expected to gain traction from Q4. However, private investment and exports may remain subdued as external demand is still anaemic. Likewise, as pricing power of firms remain weak due to subdued demand and Covid-related disruptions including labour shortages and high transportation costs could continue to impose cost-push pressures.

So even though households expect prices to decline modestly between October and December, RBI's assessement indicates inflation easing closer to the 4% target only by Q4. CPI is likely to print at 5.4-4.5% in H2 and 4.3% for Q1, FY22. 
 
Lastly, the policy review isn't without any mood lifters. To rationalize spreads of state government bonds, Das decided to conduct open market operations as a special case this fiscal. For seamless online transactions, RTGS will be round the clock, while targeted long-term repo operations (TLTRO) of Rs 1 lakh crore will ensure sytem liquidity remains comfortable. 

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Giving a fillip to the real estate sector, Das decided to rationalis risk weights of housing loans and link them to loan to value ratio up to March, 2021. He also revised regulatory limits for retail portfolio of banks by enhancing individual thresholds to Rs 7.5 crore from Rs 5 crore to facilitate higher credit flow to small businesses and individuals. 

Batting for orderliness in financial markets and dispelling uncertainty, Das said the central bank stands ready to conduct market operations with cooperative solutions to support the government's borrowing programme in H2, FY21.