Unexpected policy timing, expected outcome: These measures could help RBI disinfect the economy 

RBI realistically acknowledged that growth is expected to contract in FY21, while inflation is expected to remain elevated in the near term.

RBI’s relief measures round-three restates the intention to ease the functioning of the financial markets and easing the market risks brewing in the economy amidst the deteriorating economic outlook. While the policy meeting got preponed unexpectedly by a fortnight, most of the measures announced were broadly in line with expectations ranging from 40bps cut in repo rate cut, extension of the moratorium by another 3 months, conversion of interest on working capital into a term loan to provide cash flow relief to the borrowers, extension of support to external trade, steps to ease financial constraints of the state governments and relaxation in VRR norms for FPIs.

Notably, given the uncertainties RBI gave directional view on the growth-inflation trajectory while refraining from providing any specific forecasts.  RBI realistically acknowledged that growth is expected to contract in FY21, while inflation is expected to remain elevated in the near term ([email protected]% average) amidst supply side disruption. However, in 2H RBI expects inflation to trend lower than 4% ([email protected]% average) thereby providing room for further easing. 

While the supply and demand side disruptions definitely makes the forward looking inflation trajectory uncertain, growth is definitely likely to remain in the negative zone. We expect Real GDP growth at (-) 5.8% in FY21, with likely stability visible by the end of 3QFY21. In that backdrop, we see room for further easing by 25-35bps. However, any additional easing beyond that may become difficult given the limited space available with the money market rates already trading far below the reverse repo rate. The average overnight rates have been trading around 3%, ~75bps below reverse repo rate over the last month when RBI announced the widening of the policy corridor. After today’s 40bps rate cut, we could see effective weighted average overnight rates closer to 2.5-2.6% clearly limiting any aggressive policy easing going ahead. Any case, lowering rates is not incrementally expected to provide any meaningful impact on the issues plaguing the financial and real economy.

With the third round of measures done, RBI will need to expand the bouquet by addressing further the market and credit risks. There should be a clear communication by the RBI on aggressive OMO purchases. The Central Bank can also allow for HTM provisions for G-Sec and SDLs issued in 1HFY21, given the heavy supply pressure building in the market. Eventually under extreme stress, the central bank will need to explore direct monetization of government deficit but that decision could be back loaded. Special deposit facility could be introduced for prudent liquidity management and deployment—although such a move would only benefit the shorter end of the yield curve. Additionally, one-time loan restructuring for distressed assets should be explored. The government under the Special Liquidity Scheme, may look to tweak the tenure of the scheme for NBFCs/HFCs beyond 3 months and probably can consider expanding it for distressed corporates as well. 

(Upasna Bhardwaj is Senior Economist at Kotak Mahindra Bank. The views expressed are the author’s own)

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