The RBI’s monetary policy was on expected lines – not merely with respect to the headline policy rates, but also the enablers that the Reserve Bank of India (RBI) has consistently tried to build as a response to the pandemic – that of providing adequate liquidity, managing the government security yields and push credit to segments that are starved of funds. The RBI finds itself in a bit of a challenging situation now whereby the second COVID-19 wave has worsened the growth prospects and once again truncated the recovery process that was evolving during Q3 and Q4 of FY21. However, inflation forecasts have been upped, keeping in line with the higher fuel and imported inflation components.
Factoring in the current scenario, the RBI has brought down its growth estimates by 100bps to 9.5 per cent. The RBI also seemed confident that with the waning out of the second wave of virus and also the proliferation of the vaccination drive, growth will once again start normalizing from Q2FY22. However, very importantly, the RBI thinks that most of the current inflation is supply-side driven and hence can be looked through. However, if the RBI is expecting growth to normalize starting from Q2FY22, it needs to be extremely cautious of the demand side story creeping into inflation projections, if actually growth outturns become better-than-expected.
This is where the other measures of the RBI come in. The RBI continues its endeavor to keep financial market conditions easy. The provision of liquidity to the stressed sectors in the economy is mostly to keep the supply chain from contracting. Thus, the RBI has provided for Rs 150 billion to the contact intensive sector that have failed to even get a chance to fully revive from the disruption during the first wave and before the second wave struck. In a bid to further support lending from the SIDBI to the micro, small and medium enterprises, it was provided with a Rs160bn support. Doubling of the exposure threshold under Resolution Framework 2.0 is likely to help a wider range of borrowers to take advantage of this measure, thereby again ensuring that supply chains are not eroded.
The central bank has also entrusted itself with the critical task of keeping the nerves in the bond market calm and preventing any significant rise in bond yields, despite the large supply side pressures. This is also to ensure that the monetary policy signals are not damaged by a general rise in the Government securities yield, which forms the base for determining borrowing rates by businesses. In an endeavor towards this, the last bit remaining under G-SAP 1.0 was announced for June 17 and also keeping in line with market expectations a G-SAP 2.0 was announced for Q2FY22 with the quantum increasing by 20 per cent over the Q1FY22 commitments. This becomes relevant as the RBI had to devolve a certain part of its market borrowing programme on the Primary Dealers, implying that the market demand for government bonds have weakened.
Important also to note that Rs 100 billion of the last leg of G-SAP 1.0 is earmarked for state loans. This, in my opinion, is an admission of the stress that could be there at the State Level in terms of its fund requirements and the RBI would not want the spread of the SDL papers to rise much above the underlying G-secs. It is expected that G-sec 10-year yields will be within a very narrow range of 5.95-6.10 per cent for most part of the year and the yield curve will remain steep.
That said, the RBI has its job cut out from here on. With inflation pressures likely to remain intact, the other critical input for the RBI will be the global monetary policy conditions, especially in the US. True, the RBI has adequate FX reserves to stem any depreciation pressures of INR, but that will no doubt upset the rupee liquidity conditions that RBI would like to continue with. Having said, we do not expect any normalization process to take shape at-least for the remainder of this FY.
Indranil Pan is chief economist at YES Bank. Views expressed are personal.