The RBI has kept the repo rate unchanged at 4% while maintaining its accommodative policy stance. The Monetary Policy Committee (MPC) of the RBI voted unanimously in favour of keeping the policy repo rate unchanged for the second consecutive time. The RBI also continued with its accommodative policy stance and mentioned that it would maintain the stance for as long as necessary 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 range going forward.
The central bank expects real GDP to contract by 9.5% in FY21, with risks tilted to the downside.
The highlights of the policy are below:
1. Policy measures – Repo rate kept unchanged at 4%.
2. GDP – Real GDP expected to contract by 9.5% in FY21, with risks tilted to the downside.
3. Inflation – Decided to view the high current inflation as transient owing to supply disruptions caused by the COVID-19 pandemic and focus on reviving growth. Upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and the base effect.
4. Stance – RBI continued with its accommodative policy stance. It proposes to maintain the stance as long as necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target range.
5. Other measures
–RBI to conduct on tap Targeted Long Term Repo Operation (TLTRO) with tenors upto 3 years for a total amount upto INR 1 trillion at a floating rate linked to the policy repo rate. The scheme will be available upto March 31, 2021.
–Investments made by banks under this facility will be classified as ‘Held to Maturity’ (HTM) even if such investments exceed the permissible limit of 25%.
6. Outlook
–Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.
–The short to medium segment of the curve is attractive due to relatively lower supply in H2 borrowing and relatively attractive valuation.
–RBI highlighted that while there is space for rate cuts, it would like to use this space more judiciously. The future rate actions to hinge upon relevant incoming data.
Post the announcement, the market turned bullish and yields softened by 7-10 bps across the yield curve. The RBI assured market participants that it will continue to maintain comfortable liquidity conditions and conduct market operations in the form of outright and special OMOs. The size of these auctions has doubled to INR 200 billion which may aid bond market sentiments. Further, the announcement on OMO purchases of SDLs is likely to help alleviate supply pressures. Post this announcement, the SDL yields were down by 12-15bps.
The RBI expects real GDP growth in FY21 to be at – 9.5%, with risks tilted to the downside; For Q2FY21, it expects GDP to grow at -9.8%, for Q3FY21 at – 5.6%, and for Q4FY21 at 0.5%. It expects Q1FY22 real GDP growth at 20.6%. The RBI indicated that increased government spending, good rural demand, and robust outlook for agriculture sector augur well for the economy.
On the inflation outlook, the RBI indicated that while supply-chain disruptions are likely to dissipate, aggregate demand is likely to stay subdued. The MPC has decided to view the high current inflation as transient owing to supply disruptions caused by COVID-19 pandemic and focus on reviving growth. The RBI also mentioned that upside risks to inflation may be mitigated by a normal monsoon, arrival of new crops, and due to base effect. Lower inflation will provide headroom to the RBI for continuing with the accommodative stance.
The RBI is focused on ensuring a non-disruptive borrowing program. Scaling up the size of OMOs, introducing on-tap TLTROs, extending HTM limits for banks, and introducing OMOs in SDLs are all steps that are aimed at alleviating funding pressures across the economy. In absence of a calendar for OMOs, market may expect the RBI to use OMOs tactically, as and when the need arises. The short to medium segment of the curve is attractive due to relatively lower supply in the H2 borrowing and relatively attractive valuation. The RBI highlighted that while there is still space for further rate cuts, it would like to use this space more judiciously. Future rate actions by the RBI to hinge upon relevant incoming data.
Source: Excerpts from a note on RBI policy by Franklin Templeton.
