RBI monetary policy: As economic contraction looms, majority see rate pause

Contracting economy, rising bond supply, inching up of long-term rates reduce prospects of successive rate cuts

Opinions are divided about the course of action the Reserve Bank of India (RBI) could possibly take in the upcoming monetary policy review. This is because a contracting economy due to coronavirus (Covid-19) along with lockdowns, rising bond supply and inching up of long-term rates reduce the marginal efficacy of successive rate cuts.

A Business Standard poll of 10 economists and bond market participants does not come to a conclusion as to whether the RBI would cut rates or exercise a pause. There are some expectations of a cut on the reverse repo side and there may be further liquidity enhancing measures, but there is no consensus. The bias, though, seems to be towards a pause. Out of the 10, three expected a cut, while seven said there would be a pause. All the three bond market participants polled expected a pause.

The six-member monetary policy committee (MPC) will be meeting between August 4 and August 6 after easing repo rate by 115 basis points since March, when the country went into a lockdown to contain Covid-19. The rate cuts in March and May add up to the previous rounds of cuts, and since February 2019, the central bank has reduced repo rate by 250 basis points to a record low of 4 per cent. 

Repo is the rate at which the central bank infuses liquidity into the system by lending to banks. The reverse repo rate, at which it removes liquidity, is at 3.35 per cent. The CPI inflation declined to 6.09 per cent in June 2020 from 6.27 per cent in May. The surplus liquidity in the banking system was a little more than Rs 6 trillion on July 30.

“From a pure macro perspective, the RBI should not do anything as the marginal benefit of rate cuts are now lower,” said Indranil Pan, chief economist at IDFC First Bank.

“The RBI has maintained adequate liquidity and provid­ed for targeted flow of fu­nds to certain category of borro­w­ers. However, the RBI has pro­bably locked itself in a corner and would have to provide a cut to prevent any souring of sentim­ent,” said Pan. He expects a 25 ba­sis points (bps) cut in repo rate on Thursday.

 

June’s retail inflation should not hold the MPC back from delivering whatever little scope there is, said Upasna Bhardwaj, chief economist of Kotak Mahindra Bank. The previous rate cuts had been done in anticipation of inflation remaining benign in the second half of 2020-21.

“While we agree with the recent upside inflation prints, the rate cut call has become a close one. We will continue to see 25 bps of further easing in August, followed by a pause. Additionally, the RBI may look to widen the policy corridor with a 35 bps cut in reverse repo to further boost transmission,” said Bhardwaj.

Sameer Narang, chief economist of Bank of Baroda, expect a 25 basis points rate cut. “While inflation is above the RBI’s tolerance band, an estimated 25 per cent fall in Q1 GDP calls for rate cut to support growth and continue the transmission process,” said Narang.

At the same time, others don’t expect the RBI to cut rates at all.

“The RBI will certainly not lower repo rate,” said Rupa Rege Nitsure, group chief economist of L&T Fina­nce. “It may reduce the reverse repo rate but chances are limited. The yield curve has steepened at the longer end due to increased risk aversion and concern over a likely increase in government market borrowings. The RBI will try to give comfort on liquidity creation to support the large supply of dated government securities,” Nitsure said. She added that the RBI could announce a one-time loan restructuring to give a boost to lending and end moratorium.

“We expect a hold on policy rate. The demand slowdown is mainly because of job losses and halt in economic activity due to the pandemic-induced lockdown. Even otherwise, monetary space available is very limited and if it is used right now, almost nothing will be available with the monetary authorities in the near future,” said Devendra Pant, chief eco­nomist at India Ratings and Research.

Similarly, Madan Sabnavis, chief economist of CARE Ratings, does not expect a repo rate cut. “Inflation is high and there has been good transmission already. But there is a scope for a 35-50 basis points cut, going ahead,” Sabnavis said.

Gaurav Kapur, chief economist of IndusInd Bank, expects a pause. Kapur pointed out that money market rates are now aligned closer to the reverse repo rate of 3.35 per cent, instead of the policy repo rate of 4 per cent. “On the back of large durable liquidity surplus, the effective easing has been almost 180 bps. That is more than the policy rate easing of 115 bps. The MPC members can, therefore, wait and watch until the next meeting in October,” Kapur added.

Bond market participants also do not expect a rate cut in August.

“India has probably the highest negative real rates already in its peer group. So a dovish tone, accommodative policy, and promise of further rate cuts are there if inflation comes down, but pause as of now,” said Harihar Krishnamurthy, head of treasury at First Rand Bank.

There is no need for a rate cut now, but the need could arise after October when the RBI must oblige, said Jayesh Mehta, country head of tre­­asury at Bank of America. Badrish Kulhalli, fund manager (fixed income) at HDFC Life, said measures to imp­ro­ve transmission of previous rate cuts as well as any support measures for keeping bond yields soft could be expected.