The outlook of the economy of the country is unclear, given the continuing COVID 19 spikes necessitating extensions of localized lockdowns.
In this complicated context, the MPC kept the policy rates unchanged in its August 2020 review, in a unanimous decision, in line with its primary mandate of ensuring CPI-inflation within a band of 4% +/-2%. This contrasted with the expectation of a front-loaded rate-cut despite the high inflation prints, in a bid to signal some support to the economy.
However, the MPC stated that supporting a revival assumes primacy in the conduct of monetary policy and, therefore, it retained the position as accommodative. This signals that the gate remains open for further rate reduction. However, the extent of the same is likely to be modest, given the MPC’s emphasis on using the available policy space judiciously.
Looking forward, the MPC revealed discomfort on a multitude of inflation risks, related to supply-chain disruptions, high vegetable prices, stickiness in protein prices, increased taxes on fuels, rising asset prices and, volatility in financial markets. Accordingly, it expects inflation to remain elevated in Q2 FY21, and then record a base-effect-led moderation in H2 FY21.
In terms of the real sector, the MPC emphasized that the prospects for agriculture have strengthened with healthy Kharif sowing, rainfall and reservoir levels, and concluded that a revival in the rural sector is underway. Further, it indicated that firms are hopeful of a gradual pickup in domestic demand. External demand is highly likely to remain muted amid the ongoing global economic uncertainty. Therefore, the MPC expects a reduction in real GDP in FY21.
While the MPC was constrained by inflation, RBI unwrapped a slew of measures to support the economy like increasing the LTV on gold loans, including restructuring for individual and corporate loans, additional liquidity to NABARD and NHB, and reduction in risk weights for banks’ investments in debt mutual funds. The biggest announcement is the proposed restructuring of individual and corporate loans. This is expected to deliver some support to borrowers, some of whom have faced severe cash-flow challenges during the lockdown. Moreover, this will offer some near-term relief to Banks, by reducing their reported NPAs and capital requirements.
The moratorium that had first been approved from March-May 2020, had been extended earlier by the RBI up to August 2020. Loans under moratorium stood at as much as half of the entire loan book at the system level, as on April 30, 2020. However, almost all the lenders have reported a decline in the same during the second phase of the moratorium.
As we move ahead, the high-frequency indicators of the real sector will give out a gradual recovery from the lows displayed in Q1 FY21, characterized by unevenness across sectors and regions.
Accordingly, the MPC may well remain in a play a waiting game in its next scheduled policy meeting in October 2020, with a final rate cut likely to be delayed to December 2020.