Amid an uncertain inflation outlook and expectations of a collapse in growth, the Monetary Policy Committee (MPC) of the RBI voted five to one for the 40-bps cut in benchmark rates, with member Chetan Ghate voting for a 25-bps cut.
The monetary policy’s shift of focus to growth, prompted by the severe economic stagnation, is borne out by extra emphasis on improving transmission of lower rates, by augmenting industry’s access to working capital, elongating the borrowers' repayment curve to ease debt servicing stress and relaxing asset classification norms. In his statement, governor Das said, “It is in the growth outlook that the MPC judged the risks to be gravest. The combined impact of demand compression and supply disruption will depress economic activity in the first half of the year."
In another departure from the established practice, the central bank refrained from providing a guidance on gross domestic product (GDP) growth for fiscal 2021, or the likely trajectory for inflation. In fact, Das said, “Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in negative territory, with some pick-up in growth impulses from H2:2020-21 onwards."
In terms of specific measures, RBI allowed working capital borrowers more time to repay accrued interest. The central bank also permitted banks to extend the moratorium on loans by another three months to 31 August. That apart, the RBI increased the group exposure limit for banks to 30% of the lender’s capital base from 25% earlier. The increased limit will be applicable up to 30 June, 2021. This move will ease funding pressure for corporates who are finding it difficult to access capital markets.
Meanwhile, bankers believe that the conversion of interest on working capital loans for the moratorium period into funded interest term loan (FITL) will give a breather to borrowers. “The time period for repayment of that component could have been longer than just seven months," said Padmaja Chunduru, managing director & chief executive officer (MD & CEO) of Indian Bank.
Das noted that monetary policy transmission to banks’ lending rates has continued to improve and the one-year median marginal cost of funds-based lending rate (MCLR) declined 90 bps between February 2019 and 15 May, 2020. This comes when credit growth is falling as borrowers shun new loan during the lockdown and instead look for repayment deferment on existing debt.
Markets sent mixed signals in response to the RBI's rate action. Equity markets disapproved of the move, with Sensex closing over 260 points down. However, bonds rallied with yields on the benchmark 10-year sovereign bonds dropping 7 bps to close at 5.96%. The rupee closed at 75.96 per US dollar, 0.44% weaker than its previous close.
Experts said the central bank has room for further cuts. Rahul Bajoria, chief India economist at Barclays Bank, said he expects another 50 bps rate cuts, most likely to be delivered by end-June or early July. “This keeps our projection of terminal repo rate at 3.50%, with risks clearly biased towards rates going further lower."
The governor and the MPC painted a grim picture of the economy.
According to Das, domestic economic activity has been severely impacted by the ongoing lockdown, aimed at curtailing the spread of coronavirus. The top six industrialised states that account for about 60% of industrial output are largely in red or orange zones. Governor Das noted that demand has been severely impacted, pointing out that the biggest blow from covid-19 has been to private consumption, accounting for about 60% of domestic demand.
“Amidst this encircling gloom, agriculture and allied activities have provided a beacon of hope on the back of an increase of 3.7% in foodgrains production to a new record," said Das.
The monetary policy committee, Das said, feels that headline inflation may remain firm in the first half of FY21 but should ease in the second half aided also by favourable base effects. By Q3 and Q4 of the current financial year, the MPC expects that the headline inflation will fall below the target of 4%.
“Thus, the forward guidance of the MPC is directional rather than in terms of levels. Going forward as and when more data are available, it should be possible to estimate the path of inflation with greater certainty," he said, adding that the inflation outlook has become complicated by the release of partial information on the consumer price index (CPI) by the NSO, obscuring a comprehensive assessment of the price situation.
The MPC believes that the macroeconomic impact of the pandemic is turning out to be more severe than initially anticipated, and various sectors of the economy are experiencing acute stress.
Given the economic compulsions and unfolding financial stress, Das said RBI’s goals are to improve liquidity in the financial system, ensure smooth functioning of financial markets, to deepen financial inclusion and to preserve financial stability.