’The RBI left the rates unchanged and yet delivered an extremely dovish monetary policy by taking measures to keep the risk free rate low and providing on-tap liquidity. Looking through the transient inflationary hump and supporting growth was a clear message sent out in today’s policy. Overall, the forward guidance was extremely favourable as there was an explicit message to keep policy accommodative at least until FY 2022.
The new external MPC members appear to be more dovish in their policy views. In past, they have been quite vocal on liquidity, credit market dynamics, and have advocated for the RBI to look at unconventional or untested measures. The minutes of the meeting, which will be released a fortnight later, will be an important document to watch to gauge their views now (within the mandate of inflation targeting framework).
The RBI finally came out with its expectations on growth for FY21, which is only a tad short of double-digit contraction (-9.5% for FY21).
Ever since the pandemic, RBI had been advocating to do whatever it takes to support the economy and financial sector. Various regulatory relaxations announced since COVID onset had been novel, not tested through time and yet very appropriate and timely. On-tap TLTRO, the introduction of round-the-clock RTGS facility, co-origination of priority sector loans between banks and NBFC/HFCs, and measures to boost export and housing loans announced today are very encouraging.
The RBI has expressed its discomfort on any up-move in yields. Devolvement of primary auctions to PDs on select occasions and cancellation of an OMO is a testament to that. Today, the RBI raised the quantum of OMO purchase, gave explicit guidance for OMO and for the first time, stated plans to conduct OMOs for SDL as well, thereby nudging market from all sides to invest in bonds. We commend RBI’s ‘Open Mouth Operations’ matched with ‘Open Market Operations’. Given the constrained fiscal situation, the government had mostly focused on reforms, while RBI has done the heavy lifting to lend liquidity in the economy.
Over the last few months, the central bank had been juggling through multiple objectives- of keeping the inflation low, managing rupee and bond yields – all of which almost impossible to achieve simultaneously. With inflation shooting past RBI’s comfort zone, it was understandably reluctant to inject more liquidity. On top of that, high Balance of Payments (BoP) situation has already lent considerable rupee liquidity in the system. So the central bank has shied away from an explicit purchase of government papers, which raised the market’s concern amidst increased fiscal deficit. The lack of RBI buying in Q2 led to the 10 years G-sec remaining sticky around 6% since June.
Something eventually had to give- either rupee appreciates or bond yield sell-off or liquidity injected to prevent these outcomes despite high inflation. Eventually, it appears that the central bank had sided with easing the liquidity and nudge yields down.
With India experiencing a large demand shock, and fiscal space not unconstrained, it will be important to ensure the monetary easing achieved thus far is not reversed. To that extent, the explicit OMO guidance is a welcome move. Our view has been that despite the higher G-sec supply this year, a little extra push from the RBI amidst low bank credit and higher private savings will enable the increased government borrowing to go through non-disruptively in this exceptional year. RBI’s buying will catalyze market appetite as well. In particular, banks are flushed with deposits While incremental bank credit FYTD has been a negative of Rs.1.5 trillion. Further, to the extent that the rise in inflation is supply-side driven while demand and employment stay weak and till the extent it does not become more generalised, it should not pose many challenges for RBI. In the long run, supply-side reforms should help lower inflation trajectory.
As such, we continue to remain constructive on duration. On equities, our approach continues to be bottom-up’’.
