Review of RBI Credit Policy February 2020
Infyture, Investment For Your Future
Monetary
Policy Committee (MPC) t unanimously voted in favour of keeping the
policy repo rate unchanged at 5.15%. Further, it also voted in favour
of maintaining an accommodative stance. The reverse repo rate and Cash
Reserve Ratio (CRR) remains unchanged at 4.90% and 4.0% respectively.
RBI revised its inflation forecast upward with new projected inflation being 6.5% for Q4FY20, 5.4%-5.0% for H1FY21 and 3.2% for Q3FY21 as against forecast of 5.1-4.7% and 4.0-3.8% in H2FY20 and H1FY21 respectively in December 2019 policy. This revision was driven by sharp increase in vegetable prices, strengthening of prices of other food items like milk, pulses, meat & egg, etc and one-time impact of custom duties increase. However, impact of aforesaid will be partially set off by fall in crude prices and base effect. Moreover, core inflation (CPI ex food & fuel) is likely to remain soft given the favorable base effect and subdued domestic demand.
RBI expects GDP growth at 6.0% in FY21 (5.5-6.0% in H1 and 6.2 per cent in Q3) from earlier estimate of 5.9-6.3% for H1FY21 in December 2019. The improvement in growth in FY21 is likely to be driven by growth in personal consumption, especially rural, on back of improved rabi prospects. Also, the rise in food prices should also support the rural income. Further, the rationalisation of personal income taxes, easing global trade uncertainties, better rate transmission could boost demand, encourage exports and support investment spending. RBI also noted widening of fiscal deficit to 3.8% in FY20 from budgeted estimate of 3.3% is also supportive of growth. RBI noted that while there are some signs of pickup in economic activities, sustainability of the same needs to be monitored.
Despite upward revision in inflation forecast, RBI decided to keep the repo rate unchanged due to muted growth and because higher inflation was driven mainly by higher vegetable prices, especially onion. While vegetable prices (especially onion) are likely to moderate over next few months, RBI admitted that there is significant uncertainty on inflation outlook. Further, it mentioned that there is still some monetary space for future rate cuts but will continue to monitor incoming data for more clarity on inflation and growth outlook.
In a significant step, RBI announced conducting Long Term Repo Operations (LTRO) of 1 year and 3 years upto a total amount of INR 1 lakh crores at the repo rate against the Gsec holdings. This should improve & smoothen the liquidity for banks and support credit growth.
RBI also announced following measures
RBI revised its inflation forecast upward with new projected inflation being 6.5% for Q4FY20, 5.4%-5.0% for H1FY21 and 3.2% for Q3FY21 as against forecast of 5.1-4.7% and 4.0-3.8% in H2FY20 and H1FY21 respectively in December 2019 policy. This revision was driven by sharp increase in vegetable prices, strengthening of prices of other food items like milk, pulses, meat & egg, etc and one-time impact of custom duties increase. However, impact of aforesaid will be partially set off by fall in crude prices and base effect. Moreover, core inflation (CPI ex food & fuel) is likely to remain soft given the favorable base effect and subdued domestic demand.
RBI expects GDP growth at 6.0% in FY21 (5.5-6.0% in H1 and 6.2 per cent in Q3) from earlier estimate of 5.9-6.3% for H1FY21 in December 2019. The improvement in growth in FY21 is likely to be driven by growth in personal consumption, especially rural, on back of improved rabi prospects. Also, the rise in food prices should also support the rural income. Further, the rationalisation of personal income taxes, easing global trade uncertainties, better rate transmission could boost demand, encourage exports and support investment spending. RBI also noted widening of fiscal deficit to 3.8% in FY20 from budgeted estimate of 3.3% is also supportive of growth. RBI noted that while there are some signs of pickup in economic activities, sustainability of the same needs to be monitored.
Despite upward revision in inflation forecast, RBI decided to keep the repo rate unchanged due to muted growth and because higher inflation was driven mainly by higher vegetable prices, especially onion. While vegetable prices (especially onion) are likely to moderate over next few months, RBI admitted that there is significant uncertainty on inflation outlook. Further, it mentioned that there is still some monetary space for future rate cuts but will continue to monitor incoming data for more clarity on inflation and growth outlook.
In a significant step, RBI announced conducting Long Term Repo Operations (LTRO) of 1 year and 3 years upto a total amount of INR 1 lakh crores at the repo rate against the Gsec holdings. This should improve & smoothen the liquidity for banks and support credit growth.
RBI also announced following measures
- Allowed scheduled commercial banks to deduct the incremental credit
disbursed as retail loans for auto, residential housing and loans to
MSME etc between January 31, 2020 and July 31, 2020, from net demand
& term liabilities for the purpose of maintenance of CRR.
- Extended the restructuring window for MSMEs without asset classification downgrade to December 31, 2020 from March 31, 2020.
- Allowed the extension of date of commencement of commercial
operations of project loans for commercial real estate by one year
(delayed for reasons beyond the control of promoters) without
downgrading the asset classification.
Conclusion and Outlook
The MPC’s decision of keeping the policy rate unchanged and maintaining “an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target” was in line with expectations.
The announcement of conduct of LTROs of 1 and 3-year duration at repo rate came as a positive surprise and led to yields of government bonds of Upto 5 years’ maturity rallying by 15-25 bps. At the longer end, Gsec yields rallied between 5 to 10 bps. Thus, Gsec yield curve steepened. This also validates our view, which we have been highlighting for some time now, that the short to medium end of the yield curve offers better risk adjusted returns.
Going forward, given that RBI is expecting inflation to be below target only after 9 months amidst some sign of pickup in economic activities, any future rate action by RBI is likely to be data dependent.
Further, with regard to yields at the longer end, we maintain our view that opposing forces are at play. Easing stance of major global central banks, ample inter banking liquidity, steepness of yield curve, no additional market borrowing for FY20 and weak credit growth favor lowers yields. On the other hand, aggressive revenue assumptions leading to risk of fiscal slippage for FY21, excess SLR (Statutory Liquidity Ratio) investments within banking system, high near term headline inflation, possible bottoming out of growth, etc. are likely to impact yields adversely. In view of the above, yields at the longer end of the curve are likely to trade within a range in foreseeable future.
Considering the aforesaid factors, we maintain our view that the short to medium end of the yield curve offers better risk adjusted returns. Hence, we continue to recommend investment in short to medium duration debt funds. Further, the prevailing high credit spreads also creates a favorable risk rewards opportunity in select pockets, in our opinion.
The MPC’s decision of keeping the policy rate unchanged and maintaining “an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target” was in line with expectations.
The announcement of conduct of LTROs of 1 and 3-year duration at repo rate came as a positive surprise and led to yields of government bonds of Upto 5 years’ maturity rallying by 15-25 bps. At the longer end, Gsec yields rallied between 5 to 10 bps. Thus, Gsec yield curve steepened. This also validates our view, which we have been highlighting for some time now, that the short to medium end of the yield curve offers better risk adjusted returns.
Going forward, given that RBI is expecting inflation to be below target only after 9 months amidst some sign of pickup in economic activities, any future rate action by RBI is likely to be data dependent.
Further, with regard to yields at the longer end, we maintain our view that opposing forces are at play. Easing stance of major global central banks, ample inter banking liquidity, steepness of yield curve, no additional market borrowing for FY20 and weak credit growth favor lowers yields. On the other hand, aggressive revenue assumptions leading to risk of fiscal slippage for FY21, excess SLR (Statutory Liquidity Ratio) investments within banking system, high near term headline inflation, possible bottoming out of growth, etc. are likely to impact yields adversely. In view of the above, yields at the longer end of the curve are likely to trade within a range in foreseeable future.
Considering the aforesaid factors, we maintain our view that the short to medium end of the yield curve offers better risk adjusted returns. Hence, we continue to recommend investment in short to medium duration debt funds. Further, the prevailing high credit spreads also creates a favorable risk rewards opportunity in select pockets, in our opinion.
Sources:
Various publications
Disclaimer: The
information provided herein is based on publicly available information and
other sources believed to be reliable, but involve uncertainties that could
cause actual events to differ materially from those expressed or implied in
such statements. The document is given for general and information purpose and
is neither an investment advice nor an offer to sell nor a solicitation. While
due care has been exercised while preparing this document, we do not warrant
the completeness or accuracy of the information. We will not accept any
liability arising from the use of this material. The recipient of this material
should rely on their investigations and take their own professional advice.
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