Preview of RBI's Monetary Policy
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RBI will conclude its Monetary Policy Meeting on 6th February, and a pause could be the most likely scenario. The prescription however remains to cut interest rates further. The Central Governments projection to keep fiscal deficit for FY21 at 3.5% of GDP clearly indicates that the monetary policy will have to do most of the heavy lifting to revive demand and kick start the credit cycle. RBI’s action since Feb’19, when it began cutting interest rates, has progressed towards focusing on transmission from outright reduction in interest rates. We believe that India’s real rates at the long end remain elevated, credit growth subdued and transmission patchy. In this back drop it is most suitable for the Reserve Bank to use its communication tool to the best effect. It has continued to keep its stance accommodative but hasn’t utilized forward guidance to a great effect. It could signal its intention of keeping interest rates lower for longer and put forth possible steps toward better transmission of rates. With pressure on yields muted, there is a case for RBI to continue with rate cuts. However, given its past commentary, RBI is likely to give more weight to Inflation numbers while continuing to be in accommodative stance.
Though the headline inflation shot up to 7.3% in December, the key driver was vegetable inflation soaring up by 60% Y-o-Y. RBI in its last meeting had highlighted that vegetable inflation is expected to cool off from February onwards. Looking at daily mandi prices, onion prices have declined form a peak of Rs.180 kg to as low as Rs. 40 in some parts of the country. Fuel prices have remained capped and with the near collapse of global oil and commodity prices we believe that the Reserve Bank should be worried about another round of soft inflation patch. Ex food and Fuel, Core inflation stood at 3.7% in the last reading, with some uptick from increases in telecom tariffs-a supply side phenomenon. Owing to muted demand, also witnessed in other indicators such as Non-Oil imports, Core inflation is unlikely to sustain near term buoyancy. Therefore, headline inflation will cool off and near-term future inflation expectation remains well in RBI’s inflation target band of 2-6%
Of the 135 bps rate cut, Weighted Average Lending Rates on fresh loans are down by just 33 bps and that on outstanding loans has gone up 1 bps. Weighted Average Deposit Rates are down by 22 bps, which should aid transmission. GOI, in its recent budget, has maintained its dependency on small savings. Therefore, the deposits rates there are unlikely to go down. However, our analysis suggests that small savings are too small to compete with banking deposit rates. Therefore, both deposits and lending rate should be brought down.
Outlook - RBI Could opt For a Pause, But the Need for Further Rate Cuts Persists.Overall, we believe RBI could continue to be on the wait and watch mode but the need for rate cuts for the economy is not over yet. With Nominal growth moderating to 10%, yields should be brought down further from the current levels. Therefore the prospection remains to continue and persist with rate cuts as well as to maintain ample liquidity.
Sources:
Various publications
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