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Making Sense of the RBI Monetary Policy

Ashray Ohri | August 20, 2020
Making Sense of the RBI Monetary Policy

In its bi-monthly policy dated 6 August 2020, the RBI Monetary Policy Committee (MPC) decided to maintain the status-quo, giving precedence to inflation over contracting growth. However, taking a more judicious approach, it left space for further cuts at a more appropriate time. This came on the back of a cumulative reduction of 250 basis points in this easing cycle, starting last year (of which 115 basis points was in response to the Covid situation). The latter–along with the abundant stock of liquidity–is likely to continue providing support to financial markets.

RBI offers support through a slew of measures

The central bank continued to play its part, offering support to the reeling economy through a slew of measures on liquidity, regulatory and supervisory control. Among the more prominent ones was the extension of temporary relief to borrowers through a restructuring of corporate exposures and personal loans under the 7 June 2019 “Prudential Framework on Resolution of Stressed Assets”, along with an extension to the existing restructuring of MSME debt. To ensure resilience and financial stability against these relaxations, the eligibility criteria was restricted to viable entities facing stress only due to Covid-19 disruptions. Additional measures were announced to provide liquidity support to financial markets and improve the flow of credit in the real economy. Steps were also announced to facilitate more digitisation and use of technology to enhance functions and security in the changing periods.

RBI maintains an accommodative stance signalling future cuts at a more apt time

The MPC took a breather as it unanimously decided to keep policy rates unchanged (repo at 4%, reverse repo at 3.35%, Marginal Standing Facility and the bank rate at 4.25%), prioritising rising inflation and its uncertain outlook over the acute growth impact during the pandemic. The MPC noted a broad-based increase in price levels due to supply chain disruptions on account of the pandemic. Given the persistence of these pressures along with higher taxes on petroleum products and continued vegetable price hikes, the RBI expects inflation to remain elevated until Q2 FY 2021 before easing towards the second half of this fiscal year due to a favourable base effect and timely monsoons.

While the RBI governor highlighted the space for future cuts, he mentioned the MPC will remain watchful for a ‘durable reduction in inflation,’ to use the available space. Given that inflation is expected to remain higher for the rest of the quarter, the bar for a rate cut in the October policy has risen given the uncertainty. Nevertheless, the abundant supply of liquidity is expected to continue working its way into the real economy and provide support. To this effect, the impact of previous measures undertaken by the RBI is visible in the easing financial conditions and lower credit spreads across the spectrum of financial institutions and their respective instruments.

Credit growth remains subdued

However, despite the continued liquidity injection and steady transmission of interest rate cuts, credit growth has remained subdued as banks continue parking their excess reserves with the RBI through the reverse repo operations due to their lack of confidence to lend in the economy given the precarious financial health of both corporates and individuals. While a part of this trust deficit has been corrected with government guarantees and special purpose vehicles created by the government, these measures lay focus on supply side issues only. Meanwhile the demand for credit continues to function under stress and recovery remains enslaved to the Covid situation.

Growth in all probability to contract in FY 2021

Credit growth correlates strongly with GDP growth, which in all probability is likely to see a contraction this fiscal year after nearly four decades (the last time India witnessed a contraction in its real GDP was in 1980). While the RBI continued to refrain from putting out a numerical value to its growth projection, it mentioned that it expected to register a real GDP contraction in this fiscal year. According to a consensus among economists, India’s growth is likely to see a contraction anywhere between 5-10% in FY 2021. However, these numbers are constantly evolving as new economy data releases shed more light on the extent of economic damage.

A forecast in these unprecedented conditions is as good as a guess and one should be cautious in prematurely making any inferences. What can be more certain is the RBI will continue playing a pivotal role in alleviating financial stress and cushioning the impact of this pandemic on the real economy. As such, we could see another 25-50 basis points in RBI rate cuts by H2 of FY 2021 as inflation pressures dissipate. This is likely to reduce interest rates and cost of funds, even lower.


Ashray Ohri

Ashray is an economist based in Mumbai. He is an alumnus of the Delhi School of Economics and Mayo College, Ajmer. An avid sportsperson, Ashray represented India in the World Junior Squash Championship in 2009.

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Rohit Ohri
Rohit Ohri
3 years ago

Informative and exhaustive article…

Sandeep Chopra
Sandeep Chopra
3 years ago

The key point being ‘despite the continued liquidity injection and steady transmission of interest rate cuts, credit growth has remained subdued as banks continue parking their excess reserves with the RBI through the reverse repo operations due to their lack of confidence to lend in the economy given the precarious financial health of both corporates and individuals.’

Nirmala Agarwal
Nirmala Agarwal
3 years ago

Very good article..where u have hinted abt the demand side stress ….. even after the policy measures….
Need lot of attention n measures to curb inflationary rates..post pandemic
Would like to read more articles written by u.

Prajwal Choudhary
Prajwal Choudhary
3 years ago

Comprehensively penned down, keeping in mind the economic developments! Research-backed forecasts and insightful indeed.

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