Going into the August policy, the RBI MPC will have two conflicting data points: (1) recession remains firmly on the cards and (2) inflation during the lockdown had inched up uncomfortably above the RBI’s upper tolerance level of 6%. Given the uncertainty on the depth of the recession, the MPC will have to remain accommodative in its stance and (possibly) deliver another rate cut of around 25 bps (but will be a close one). The more important decisions (beyond the MPC’s ambit) will be on the end date of moratoriums and any potential restructuring norms. It’s not clear if the RBI would like to address it closer to the deadline of August 31 or now.
The present inflation trajectory, albeit based on an incomplete set of data, would be worrying for the MPC in normal times. In fact, the increase in the core inflation, due to increase in gold and fuel prices would have been (and even now) a substantial point of debate. In the current juncture concerns will be raised on the inflation trajectory remaining around 6% (if not higher) in the near term. However, recessionary fears will dominate over most of the inflation concerns. Keeping liquidity comfortably in surplus and keeping interest rate low for a prolonged period will continue to be the policy; but be prepared for a touch of caution on inflation and inflation expectations.
The RBI had cut the policy rate in May in anticipation of a recession in FY2021. The key question will be whether their concerns on growth have increased so as to warrant another rate cut. Efficacy of further rate cuts is limited at this point. Liquidity will continue to remain comfortably in surplus and the reverse repo remaining the de facto operative rate. Consensus seems to be building towards a reverse repo cut rather than repo rate cut. However, with retail and MSME loans linked to the repo rate, a reverse repo rate cut will not reduce credit cost. A token reverse repo rate cut also would do little to prod banks to abandon credit risk concerns and reduce parking money with the RBI.
A greater concern for markets will be the RBI’s decision on moratoriums and restructuring. The deadline for the end of the moratoriums is August 31, 2020. Bankers seem to favor discontinuation of the moratoriums and shift the focus to a one-time restructuring. However, even if the RBI were to declare its decision on moratoriums, a decision on restructuring immediately may not be feasible given that consultation on restructuring is underway with the government.
Chances are that the RBI will possibly announce its decisions closer to the end of August. However, as part of the policy discussions, the health of the financial sector should ideally feature prominently. This is important given the deep implications that the sector has on growth, especially as NPAs remain high in pockets of the banking sector and in turn impinge on the long-term growth prospects.
Suvodeep Rakshit is Vice-President and Senior Economist in Kotak Institutional Equities. Views expressed are author’s personal.