Looking at the macroeconomic indicators, the Reserve Bank of India (RBI) had to keep its policy rates intact. Repo rate at 4% and reverse repo rate at 3.35%. While maintaining its ‘accommodative’ stance, it promised to continue its supportive policy stance so long as it is necessary for ensuring durable growth and also until the Covid-19 impact is mitigated. This combines into a medium-term assurance that can potentially add a tinge of comfort to market players.
The differentiating aspect of the current policy review is the convincing optimism that can potentially propel market sentiments to boost growth. It turned the tables with its right tab on high frequency macroeconomic indicators. Diving deep into the early growth trends, it expects revival to be faster post the second wave, reflecting sustained adaptations to Covid-related protocols and easing of containment.
Despite global headwinds of razing inflation and signs of an uptick in policy rates in some countries, the reading of the RBI is well anchored that rise in CPI inflation is a transitory phenomenon that should normalise once the current supply-side disruptions recede. Crude price is a key factor that propelled inflation in many economies, even leading to a policy rate rise in some countries. The severe blow to the economic revival during the second wave led the IMF to revise its outlook on India’s growth for FY22 from 12.5% to 9.5%.
Signposts of Revival
Though the CPI-led inflation in May was 6.3%, it recorded a mild downward slope by a notch to 6.26%. Still, it is lingering above the RBI’s comfort level. It is expected to taper off below the upper edge of the RBI target of 6% once the supply-side disruptions recede and external commodities, more importantly, crude prices begin to moderate. It is noteworthy that the OPEC Plus has agreed to increase oil production to the pre-pandemic levels by September 2022 that can soften the spot and future crude oil prices from their peak in early July.
In the interim, the RBI hinted at moderation of indirect tax component of pump prices by the Centre and States. Headline inflation can further cool with fuel and food inflation calming. Taking a cue from positive developments in sight, the CPI inflation for FY22 is projected upwards from its earlier estimate of 5.2% to 5.7% but is expected to stay within its upper edge of comfort level of 6%.
Though many of the high frequency indicators dipped during May and June due to local lockdowns and closure of business units, their revival in July has been indicative of their forceful comeback. Noticeable is the resurgence of rural demand. The manufacturing Purchasing Managers’ Index (PMI) that had dropped into contraction to 48.1 in June for the first time in 11 months, rebounded well into the expansion zone with 55.3 in July. Even Services-PMI recovered to 45.4 in July from 41.2 in June showing a widening bandwidth of growth. The initial quarterly results of non-financial corporates for Q1:2021-22 and leading banks, especially the SBI, showed better profitability indicating early sign of buoyancy.
The RBI has ensured the availability of ample liquidity through its market operations, both conventional and unconventional, since the onset of the pandemic. As part of secondary market operations, the central bank continued its G-sec acquisition program (G-SAP) which could continue to anchor the market yield to facilitate government and the corporate sector to raise funds at affordable rates.
To pump prime the evolving growth nodes and continuing its liquidity support, the RBI extended the duration of on-tap Targeted Long Term Repo Operations and relaxation in marginal standing facility till December 2021. It also extended the deadline for the achievement of financial parameters under Resolution Framework 1.0 to October 1, 2022. These postponements of timelines will provide adequate liquidity and assurance to banks.
Transmission of Low Rates
The reduction in repo rate by 250 basis points since February 2019 has resulted in a cumulative decline by 217 basis points in the weighted average lending rate on fresh rupee loans. One basis point is equal to 1/100th part of one per cent. Domestic borrowing costs have eased, including interest rates on market instruments like corporates bonds, debentures, Commercial Papers, Certificate of Deposits and T-bills.
In the credit market, transmission of lending rates has been stronger for MSMEs, housing and large industries. The low interest rate regime has also helped the household sector reduce the burden of loan servicing. The significant reduction in interest rates on personal housing loans and loans to the commercial real estate sector augurs well for the economy, as these sectors have extensive backward and forward linkages and are employment-intensive. But credit growth continued to be slow. It has slightly improved to 6.5% year on year as of July 16, 2021, as against 5.8% during FY21 but it needs to be accelerated with the help of sectoral liquidity provided by the RBI. Banks should also provide a restructuring facility of loans to borrowers under the RBI’s Restructuring Framework 2.0 to provide more time for the stressed borrowers to recoup.
Looking ahead for pent up demand to acquire a durable character with an accelerated pace of vaccination, buoyant exports, pick-up in government expenditure, including capital expenditure and the recent economic package reaching the target group, a well-founded revival is in the offing.
The RBI has affirmed its positive outlook to keep the GDP estimate of FY22 at 9.5% despite some global think tanks swaying their outlook based on the temporary disruptions caused by the second wave. The RBI could boost sentiments by maintaining the status quo not only in policy rates but also by portraying an optimistic outlook striking the right balance. It has made it clear that its priority is to ensure restoration of growth. The stakeholders should be able to function while managing the lingering virus.
(The author is Adjunct Professor, Institute of Insurance and Risk Management, Hyderabad. Views are personal)
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