The Reserve Bank of India (RBI) has kept interest rates steady, belying expectation that the central bank will do-what-it-takes to support faltering economic growth. The key repo rate is unchanged at 5.15 per cent and the reverse repo rate is unchanged at 4.9 per cent. The Monetary Policy Committee (MPC) has also voted in favour of maintaining an accommodative stance, which meant interest rates are not off the table. At a time when inflation i.e. cost price rise is on the boil, it seems the RBI has paused on the interest rates. What does this mean for the economy? The Finapolis takes a look.
The MPC’s decision of keeping the policy rate unchanged and maintaining “an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target” was in line with expectations, says HDFC Mutual Fund. Going forward, given that RBI is expecting inflation to be below target only after nine months amidst some sign of a pickup in economic activities, any future rate action by RBI is likely to be data-dependent, said the fund-house.
From a debt mutual fund perspective, HDFC MF maintains its view that the short to medium end of the yield curve offers better risk-adjusted returns. Hence, it continues to recommend investment in short to medium duration debt funds. Further, the prevailing high credit spreads also create a favourable risk rewards opportunity in select pockets.
From an economic side point, lending rate cuts are key to recovery. “It is understandably reluctant to cut rates when inflation is breaching its 2-6 per cent mandate, even though this is largely fueled by a spike in onion prices that is reversing. Gov Das has clearly stated that “…barring the intensification of global risks, I would like to emphasize that there is policy space available for future action…" Looking ahead, we expect the RBI MPC to cut on April 3 or June (from April earlier), depending on how fast onion prices come down. As of now, we see CPI inflation peaking off to 6.7% in January from 7.4% in December on falling onion prices,” says BofA Securities India economists Indranil Sen Gupta and Aastha Gudwani.
Some experts, however, maintain no room for a rate cut until 2HFY21. “With inflation expected to remain elevated at least for the next six months, a rate cut is unlikely before 2HFY21. The projection for CPI inflation has been revised upwards to 6.5 per cent for 4QFY20; 5.0-5.4 per cent for 1HFY21; and 3.2 per cent for 3QFY21. Our own forecasts are slightly higher at 6.8 per cent for 4QFY21, 5.9 per cent for 1HFY21 and 4.2 per cent for 3QFY21,” said Teresa John, Economist - Institutional Equities, Nirmal Bang.
The inflation outlook is likely to be influenced by several factors.
First, food inflation is likely to soften from the high levels of December and the decline is expected to become more pronounced during 4QFY20 as onion prices fall rapidly in response to arrivals of late Kharif and Rabi harvests. Higher vegetable production, despite the early loss due to unseasonal rain, is also likely to have a salutary impact on food inflation, points out John. On the other hand, the recent pick-up in prices of non-vegetable food items, specifically in milk due to a rise in input costs, and in pulses due to a shortfall in Kharif production, are all likely to sustain. These factors could impart some upward bias to overall food prices.
Second, crude prices are likely to remain volatile due to unabated geopolitical tensions in the Middle East on the one hand, and the uncertain global economic outlook on the other.
Third, there has been an increase in input costs for services, in recent months. However, subdued demand conditions, the muted pricing power of corporates and the correction in energy prices since the last week of January may limit the pass-through to selling prices.
Fourth, domestic financial markets remain volatile reflecting both global and domestic factors, which may have an influence on the inflation outlook. Fifth, base effects would turn favorable during 3QFY21. Sixth, the increase in customs duties on items of retail consumption in the budget may result in only a marginal one-time uptick in inflation.
“We believe that the RBI has well-addressed the stress points of the economy, and this is likely to positively reflect on lowering systemic level interest rates. However, this alone is not likely to provide impetus to the consumption cycle. Although in the long run, it might help to amplify the consumption cycle once the recovery sets the pace. We still believe that an improvement in consumer sentiment through higher income levels is likely to lead to sustainable growth in the overall economy,” says Kruti Shah, Economist, Emkay Global Financial Services.
Meanwhile, the RBI has launched a series of unconventional tools used to improve transmission. Since there seems to be reluctance from banks in aligning their lending rates in response to the rate cuts (effective transmission of rates was 55bps against 135bps of rate cuts), the RBI also tried to channelize the surplus liquidity, which might impact G-Sec yields in the shorter tenor (increasing the funds available near to deposit tenure).
“We believe that the RBI’s earlier measures of Operation Twist led to a flattening of the yield curve in the longer tenor, and these measures will flatten the yield curve in the shorter tenor. In our view, this will also bring down the rates of 1-3 year G-sec considerably,” adds Shah.
Relieving banks from the short-term liquidity pressure, the RBI has allowed banks to exclude incremental retail loans to auto, residential housing, and loans to MSMEs from the calculation of NDTL for CRR which forms ~22% of non-food credit. This facility is available until July 31, 2020. The move would surely intensify the price competition among lenders and is negative for HFCs as they have fairly thin spreads and they directly compete with banks. However, vehicle/SME financing NBFCs would remain neutral to the event considering the different scale of customers (no -banked, low-ticket size and limited banking history). Such customers anyhow remain indifferent to interest rates, pointed out Shah of Emkay.
The central bank has also allowed the extension of DCCO (Date of Commencement of Commercial Operations) by one year for real estate projects (both commercial and residential) without downgrading of a/c as NPA, thereby providing relief to the banks staring at rising stress from the real estate sector (NPA@7.3% as at June 2020). The RBI also extended restructuring window for distressed SME loans by one year until March 2021 from earlier March 2020.
The writer is a journalist with 14 years of experience)