RBI POLICY – Unconventional Support to Growth, Uncertain Inflation Environment

07 FEBRUARY 2020

The Sixth Bi-Monthly Monetary Policy Statement for FY 2019-2020 was released by the Reserve Bank of India (RBI) on 6th February 2020. Following were the key highlights.

1. Repo rate was left unchanged at 5.15%

2. Stance left unchanged as “Accommodative”

Consequently, the reverse repo rate and the marginal standing facility (MSF) rate / Bank rate remains unchanged at 4.90% and 5.40% respectively.

Keeping in line with market expectations, the RBI kept policy rates unchanged. The unanimous decision to maintain status-quo was, however, accompanied with a further downgrade in growth expectations for 1HFY21 by 30-40bps to 5.5-6.0% YoY, along with an upward revision in the inflation forecast by 180bps for 4QFY20 (6.5%) and 120-140bps for 1HFY21 (5.4-5.0%).

RBI’s Policy Actions

  • To enable transmission of lower lending rates, the RBI made the following changes to the liquidity management framework:
    • 1yr and 3yr term repos worth INR 1tn offered at current policy rate (5.15%)
    • Replaced daily repos with a 14-day term repo/reverse repo operation as the main liquidity management tool
    • Apparent abandonment of the general stance of maintaining marginal liquidity deficit in the system, with the Weighted Average Call Rate (WACR) as the single operational target
  • In order to incentivize credit flow to troubled sectors, the RBI made the below changes in the macro prudential norms:
    • Exemption to banks from CRR requirement towards incremental loans to MSMEs, autos and residential housing till 31st July 2020
    • Delayed the classification of commercial real estate loans as NPAs by 1 year
    • Extended the restructuring period for stressed MSMEs loans

10 yr G-Sec movement around the current & previous RBI Policies

Source: Bloomberg

The above announcements led to a single-day fall of 15-20bps in short term bond yields and appear to be in line with the RBI’s “accommodative” stance, as per Citi analysts. They expect headline inflation to rise further towards 7.4% YoY in Jan20 (from 7.35% in Dec19) and average 6.7% YoY for 4QFY20, before trending downward in 1QFY21 and averaging 4.4% YoY in FY21.

While Citi analysts see little possibility of further rate cuts until CPI comes down towards 5% and greater transmission of past cuts is observed, they believe that the RBI has been able to use unconventional measures to improve both cost and availability of credit. In an adverse growth-inflation environment, Citi analysts expect these measures to encourage money supply growth and help stimulate the economy. However, given extreme liquidity surplus and push to improve credit flow, Citi analysts caution against the risk of inflated asset pricing and deterioration in credit quality.

Fixed Income investors may continue to focus on high credit quality with a preference for short duration and remain diversified in their portfolios. For more details and implications for your portfolio, please contact your relationship manager.

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