RBI keeps its gun powder dry as space for monetary policy easing still available

KEY HIGHLIGHTS

• Repo rate has already been reduced by 250 basis points since February last year

• Credit growth is in negative zone in the first quarter of 2020-21 as banks turn risk averse

• Headline inflation to remain high in Jul-Sept of 2020-21

• Protein based food items could also emerge as a pressure point

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has done the right thing by not reducing the repo rate from the current level of 4 per cent. The repo rate is the rate at which banks borrow from the central bank. The repo rate has already been reduced by 250 basis points since February last year, and there is surplus liquidity in the market.

There are also inflationary pressures emanating from different areas post the COVID-19 disruption. The inflation outlook is still hazy with the CPI or retail inflation in June crossing the 6 per cent mark , which is the uppermost band under the inflation mandate given to the MPC.

The MPC has a mandate to keep inflation in check with a target of 4 per cent with +- 2 per cent.  

Governor Shaktikanta Das today cited the rising inflation in emerging markets which after easing in April-May shot up in June amidst cost push pressures. There could be a similar scenario in India because of disruption in the supply chains. In fact, India-China relations, which is on a downswing, could also bring some disruption in the supply chains.

The RBI expects headline inflation to remain at elevated levels in the second quarter (July-Sept) of 2020-21. Even in food prices, the upside risks remain. "Protein based food items could also emerge as a pressure point," said Das. It may be remembered that protein items especially created a havoc in inflation numbers during the economic boom period as prices of milk, egg, cheese and other items shot up big time.

Yet another reason for MPC to vote for a status quo in the policy rate is the subdued credit growth. The credit growth is in the negative zone in the first quarter of 2020-21 as banks turn risk averse. The corporate sector is also cautious and consumer confidence is at at an all-time low because of low income, salary cuts and job losses.

The RBI will also need to focus on the interest rate transmission as the banks' NPAs are likely to shoot up to 12 to 15 per cent by the end of 2020-21 because of COVID-19 related stress. The current gross NPAs are 8 per cent plus as against the total advances outstanding.

While the restructuring mechanism offered by the RBI today will be of great help in the next 2 years, the banks will, however, have to make enough provisions to absorb the losses in future. This means higher provisioning pressure. The banks may be a bit reluctant to transmit the rate cut fully.

Lastly, the RBI would also be waiting for the another round of fiscal support to the economy from the government. The enhanced borrowing by the centre and states is already going to increase the fiscal deficit numbers. In fact, there is a possibility of debt monetisation by the government to bridge revenue gaps and also stimulate the economy. By next policy announcement in October, there will be lot of clarity on the numbers like inflation, credit growth, fiscal deficit, revenue shortfall and also debt monetisation.

Also read: RBI announces additional special liquidity facility of Rs 10,000 crore to boost housing sector, NBFCs, MFIs