RBI rate cut cycle seems to be over; projects positive growth for next two quarters

The RBI MPC’s decision to keep policy rates unchanged was on expected lines

By Sudhakar Shanbhag

The RBI MPC today kept the Repo rate unchanged at 4% and kept the stance at “accommodative”. Reverse repo rate was kept unchanged at 3.35% and MSF rate remains at 4.25%. All six members voted for keeping repo rate unchanged and retaining stance at “accommodative”. Reiterating that accommodative stance will exist as long as necessary – at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward. 

The December policy was expected to be a non-event in terms of policy actions. The RBI MPC’s decision to keep policy rates unchanged was on expected lines. The rate cut cycle it seems is over, for now. It is important to note that the RBI estimates growth to be positive in both 3QFY21 and 4QFY21 while inflation remains well above the 4% till 2QFY22. If at all, any further rate cut (25-30 bps) will be contingent on weaker-than-expected growth trajectory (sharp deceleration in growth impulses after the festive season) and/or lower-than-expected inflation trajectory. 

Though some recent expectations had built up for some liquidity action in order to align short-term rates closer to the reverse repo rate, the RBI kept liquidity policy unchanged. It is believed that inflation is not yet driven by monetary factors and, hence, surplus liquidity is unlikely to interfere with monetary policy objectives. We cannot expect major liquidity withdrawal measures in the near term.

In light of the above the severing yields are expected to remain benign in the near term and the steepness in the curve is expected to continue. 

There were some measures related to banking sector also which were announced to support growth, enhance liquidity to targeted sectors, conserve capital amongst banks/NBFCs, supervisions through credit functions, upgrade payment system services.

To enhance liquidity support, 

  • On-tap TLTRO: will now be extended to other identified 26 stressed sectors highlighted in ECLGS 2.0 scheme
  • Regional Rural Banks (RRBs)– Extension of Liquidity Adjustment Facility (LAF) and MSF to RRBs. RRBs also permitted to participate in the call/notice money market both as borrowers and lenders.

To conserve capital and ensure credit flow – no dividend to be declared for FY20 by banks and RRBs

  • To conserve capital and ensuring credit flow – it has been decided after a review that commercial banks and RRBs will retain profits made in FY20 and will not announce dividend.
  • To enhance resilience of NBFCs – criteria and parameters to be laid out for declaration of dividend

Some supervisory and governance controls announced,

  • Regulatory regime for NBFCs: A scale based regulatory approach would be a way forward. A discussion paper will be issued before Jan 2021 for public comments
  • Introduction of risk based internal audit for UCBs (Urban Co-operative Banks)/NBFCs
  • Digital payments security: RBI directions for robust governance with minimum standards of security control for channels like internet banking, mobile payments credit cards etc. Draft guidelines will be issued for public comments
  • To deepen financial inclusion & financial literacy: Centers of financial literacy were implemented as pilot projects. The aim is to expand reach from 100 blocks to every block in the country by 2024.

(Sudhakar Shanbhag is Chief Investment Officer at Kotak Mahindra Life Insurance Company Limited. Views expressed are the author’s own.)

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