As wave three looms, central bank decision to maintain status quo is cautious

As expected, the Reserve Bank of India (RBI) maintained the status quo on policy rates and cut its gross domestic product (GDP) forecast by 100 basis points. All members of the Monetary Policy Committee (MPC) voted unanimously to keep the key pension rate unchanged at 4.0%.

The RBI cut its real GDP growth projection for FY22 by 100 basis points to 9.5%. Interestingly, the RBI significantly improved third-quarter GDP growth (compared to April estimates), indicating a vaccination-induced recovery after September. At the same time, the RBI revised the inflation figures upwards. We believe that managing inflation could be a challenge for the RBI when the fuel price pass-through begins to occur.

With the pandemic ravaging the economy, RBI has continued to focus on reducing stress in specific industries through targeted liquidity measures. This was a welcome step because the amount of excess cash is not the issue, it is the distribution of that cash that is important. Thus, by continuing the ease of commissioning offered for the health sector, the policy has now extended the ease of commissioning for contact intensive sectors. Banks are expected to create a separate covid loan book as part of the program. In addition, liquidity support to SIDBI is reinforced by ₹16,000 crore and the 2.0 resolution framework thresholds for MSMEs (micro, small and medium enterprises) have also been doubled to reach ₹50 crores.

According to our estimate, nearly 3.5 to 4.5 million units (with an outstanding ₹6 to 7,000 billion) are already eligible for the Resolution Framework 2.0 below the exposure limit of ₹25 crores. The distribution indicates that nearly 80% of these units are located below the ₹10 lakh category. Increasing the limit to ₹50 crore will also include at most 5,000 units, although their outstanding amount eligible for restructuring is significant.

G-SAP 1.0 has clearly helped stabilize market expectations and provided bond market participants with clear and reassuring guidance from a management perspective of the large borrowing program. Subsequently, the policy announced G-SAP 2.0, with an enhanced limit of ₹1.2 trillion. However, some adjustments are needed in the G-SAP program to make the impact more profound in the markets.

For example, the RBI may consider focusing more on 7-8 year securities as this will smooth the curve and reduce the upward pressure on benchmark yield. In addition, it can also propose a prior maturity calendar by compartment for GSAP-2. In addition, more purchases of illiquid securities should be made compared to liquid securities in each sub-fund. Thus, banks will be able to offload their HTM shares and buy liquids.

Credit consumption remains low because companies have deleveraged by repaying high-cost loans with funds raised through bond issues. Business willingness for new investments remains low amid pervasive uncertainty. Only fiscal policy can rekindle the animal spirit at this stage and to this end we recommend using the route of automatic stabilizers to manage fiscal levers. This would mean that the budget deficit can only increase via the automatic fiscal stabilizer route, whereby a reasonable drop in fuel prices or even Goods and Services Tax (GST) exemptions for distressed entities could work wonders. .

Interestingly, our analysis of over 1,000 listed entities reveals that companies have deleveraged across industries to lower their funding costs and used the bond market route to replace high-cost debt with bond issues. . Indeed, primary bond issues, according to the CCIL, by the manufacturing sector have increased to ₹34 764 crore in FY21 from ₹5,585 crores in FY20.

In the government securities market, the low levels of limit usage by REITs at 38.4% mean that REITs have not taken a position in government securities. The RBI has now authorized licensed concessionaire banks to place margins on behalf of their REIT clients for their transactions in government securities (including government development loans and treasury bills), indicating that a certain leverage is now allowed. This will provide the necessary additional liquidity, thus controlling the returns.

Continuing its reforms on regional rural banks (RRBs), in order to offer greater flexibility in raising short-term funds, RRBs are now authorized to issue certificates of deposit (CD) to eligible investors.

There has been recent speculation suggesting that the RBI has intervened heavily in the foreign exchange market, which has made it easier to transfer large surpluses to the government. This is somewhat misleading, as RBI’s two-way intervention in the forex market since January 2021 was due to a constellation of global and domestic factors, which resulted in episodes of exits and entries.

A clear example of the RBI’s two-way intervention in the forex market could be the recent drop in one-month forward premiums, due to RBI’s cancellation of sell-buy swap transactions to buy swaps. of sale. In fact, a fall in forward premiums is even negative for unfunded carry trades and therefore could put upward pressure on the value of the rupee, which in itself is a clear move in either direction!

Overall, with the hindsight of the second wave, with the possibility of a third wave, it was prudent to maintain the status quo. One would expect adaptation measures to continue for the remainder of the year.

Soumya Kanti Ghosh is the group’s chief economic adviser at the State Bank of India. Opinions are personal.

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