The RBI's monetary policy statement is pretty much in line with market expectations. The RBI MPC has kept policy rates unchanged (repo rate at 4.0 percent), while continuing with its accommodative policy stance, for as long as necessary.
In the backdrop of the pandemic, RBI has expectedly reduced its growth projections. Its forecast of real GDP growth for FY2021-22 stands reduced by 1 percent to 9.5 percent, with downward revision in Q1 and Q2 numbers, and upward revision in Q3 and Q4 numbers.
The second COVID wave has hit urban demand, and there are some downside risks to the strong rural demand as well, given the spread of the virus into the rural parts of the country. However, the RBI expects that with the vaccination drive picking up in the coming months, economic activity should normalise quickly, and the impact of the second wave should be less than the first wave. Further, the rebound in global trade and conducive external conditions should support exports.
On inflation front, RBI has projected FY2021-22 CPI inflation at 5.1 percent, with marginal upward revision in quarterly numbers (Q2-Q4) by 20-30 bps. Risks are evenly balanced - external conditions (rising crude and commodity prices) along with the current domestic pandemic-led supply constraints are likely to create upside pressure on inflation, while on the other hand, the softening domestic demand and relaxation in the state lockdown conditions in the coming weeks should ease the pressure on inflation.
The RBI Governor also reiterated the MPC's (Monetary Policy Committee) commitment towards ensuring conducive financial conditions and adequate system liquidity. It announced the extension of the G-SAP programme to the second quarter, in the form of G-SAP 2.0. Further, it has set aside Rs 10,000 crore for SDLs (state development loans), out of the next G-SAP 1.0 tranche of Rs 40,000 crore (on 17 June).
Among the development and regulatory measures announced, the on-tap liquidity window for contact-intensive sectors, the additional special liquidity facility provided to SIDBI (to support the MSMEs’ credit requirements) as well as enhancement of the exposure thresholds for resolution of stress among MSMEs, non-MSEME small businesses and business loans to individuals are aimed at maintaining stability in liquidity and credit conditions, given the challenges faced by businesses in the current lockdown situation.
Key takeaways:
The MPC's continued accommodative policy stance (as long as necessary) reflects its determination to look through the current inflationary expectations and focus ostensibly on revival of growth.
The RBI is also sending a message to the markets that it intends to keep yields stable, through G-SAP as well as regular intervention in the form of OMOs and Operation Twist, in order to see the government borrowing programme through, in a non-disruptive manner. However, it remains to be seen how the markets react in the medium term, as it is possible that the already-ambitious borrowing programme could be further enhanced a bit, owing to the effects of the second COVID wave on various parts of the economy. G-sec benchmark yields have been trading range-bound, with the 10-year benchmark yield somewhat anchored to 6.0 percent levels, and this situation will likely persist in the near-term, until the pandemic conditions ease and economic growth starts picking up again.
Forex reserves have grown successfully to a healthy $600 billion level; the RBI is also endeavouring to keep the rupee stable and range-bound through active intervention.
RBI has been actively conducting Variable Rate Reverse Repo (VRRR) auctions on a fortnightly basis, in order to normalise the (excess) system liquidity gradually, and we expect this to continue in the near-term. Hence, there is limited scope for short-term rates to reduce further from here.
Overall, the policy appears to be neutral from the debt market's perspective.
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