MPC votes unanimously for pause; wants to use space 'judiciously and opportunistically': In line with our expectation, the Monetary Policy Committee (MPC) chose to hold rates at the Aug 4-6 review and maintained accommodative stance. While admitting that the economy is 'experiencing unprecedented stress', the committee added that its primary mandate is to control inflation. Given the high inflation rate and uncertainty around inflation outlook, the MPC's decision to prioritize price stability over growth is prudent. The Committee added that while space for further action is available, it should be used judiciously and opportunistically to maximise its beneficial effects.
- Committee refrains from giving inflation trajectory, notes inflation prints need more clarity: Deviating from past practice, the MPC refrained from giving expected inflation trajectory for the next four quarters. Instead, it gave qualitative assessment of future expectations. In the statement, the committee noted that imputed inflation prints for April-May 2020 have added uncertainty to the inflation outlook. Although the NSO adopted best practices in producing these imputations, for the purpose of monetary policy formulation and conduct, the MPC regarded inflation prints for April - May 2020 as a break in the CPI series. It further added that lockdown-related disruption, spike in food prices due to floods in eastern India, higher taxes on petroleum products, higher raw material prices and telecom charges have made the inflation outlook obscure.
- Inflation likely to remain elevated in Q2FY21, moderate in H2: MPC expects food inflation to ease due to bumper rabi harvest and modest MSP increases although perishables' prices are likely to remain contingent upon normalization of supplies. On the other hand, higher fuel prices, volatility in financial markets and rising asset prices could pose upside risks to inflation. On the net, the MPC expects inflation to remain elevated in Q2FY21 but moderate in H2 due to large favourable base effect.
- Real GDP growth in FY21 likely to be negative: The committee did not give detailed growth forecasts either. However, it added that recovery in rural economy is expected to be robust while domestic demand is expected to recover gradually through Q2FY21 to Q1FY22. External demand, on the other hand, is expected to remain anaemic.
- Financial conditions have improved significantly: The RBI noted that borrowing costs in financial markets have dropped to their lowest in a decade due to abundant liquidity. Interest rates on 3-month t-bills, CPs and CDs are trading below policy rate in the secondary market while illiquidity premia is also dissipating due to Operation Twist and TLTRO 1.0. Financing conditions for NBFCs have stabilized. Corporate bond spreads across ratings have compressed sharply, leading to record primary issuance of corporate bonds in Q1FY21. Our proprietary Financial Conditions Index (FCI) corroborates this. FCI in Feb '20 was 4.45 but jumped to 9.5 in Mar '20 and 11.2 in Apr '20 as the central bank unleashed various instruments. Although FCI has declined to 10.2 in Jul '20, it remains significantly above pre-Covid levels, indicating easier financial conditions.
- More focus on financial stability, credit discipline, capital conservation: Since the onset of Covid-19, the RBI and MPC's focus was on infusing liquidity, alleviating stress and supporting troubled sectors. While the central bank has continued to do that in the current policy as well, it is now focusing more on maintaining financial stability and credit discipline. In today's policy, the RBI announced one-time restructuring, streamlined use of multiple accounts by large borrowers, broadened the scope of priority sector to include start-ups, and harmonized differential treatment of banks' debt holdings to conserve banking capital.