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As third wave looms, central bank’s move to maintain status quo is prudent


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

RBI has reduced its projection of real GDP growth for FY22 by 100 bps to 9.5%. Interestingly, RBI has enhanced Q3 GDP growth by a large margin (from April estimates) indicating a vaccination- driven recovery, post-September. Simultaneously, RBI has revised upwards inflation numbers. We believe inflation management could pose a challenge to RBI when the fuel price pass-through starts to occur.

With the pandemic ravaging the economy, RBI has continued to focus on alleviating stress in specific sectors through targeted liquidity measures. This has been a welcome step as the quantum of surplus liquidity is not the problem—it’s the distribution of that liquidity which is important. Thus, continuing with the on-tap facility given for health sector, the policy has now extended the on-tap facility for contact-intensive sectors. Banks are expected to create a separate covid loan book under the scheme. Further, the liquidity support to SIDBI stands enhanced by 16,000 crore and the thresholds under Resolution Framework 2.0 for MSMEs (micro, small and medium enterprises) has also been doubled to 50 crore.

As per our estimate, almost 3.5-4.5 million units (with an outstanding of 6-7 trillion) are already eligible for Resolution Framework 2.0 under the exposure limit of 25 crore. The distribution indicates that almost 80% of such units are in less than the 10 lakh category. The increase in limit to 50 crore will additionally include at most 5,000 units, though their outstanding amount eligible for restructuring will be significant.

The G-SAP 1.0 has clearly helped in stabilizing market expectations—and provided a clear forward guidance to bond market players that is reassuring from the perspective of managing the large borrowing programme. Subsequently, the policy has announced G-SAP 2.0, with an enhanced limit of 1.2 trillion. However, some tweak is required in the G-SAP programme to make the impact more profound on the markets.

For example, RBI may consider shifting the focus on 7-8-year papers as this will smoothen the curve and reduce upward pressure on benchmark yield. Additionally, it can also come up with a prior calendar of bucket-wise maturity for GSAP-2. Furthermore, more purchases of illiquid securities should be undertaken as compared to liquid securities in each bucket. Accordingly, banks will be able to offload their HTM stocks and buy liquid ones.

Credit offtake continues to be low because corporates have deleveraged by repaying high-cost loans through funds raised via bond issuances. Corporate willingness for new investments remains low among the all-pervasive uncertainty. Only fiscal policy can rekindle animal spirits at this juncture and, to this end, we recommend to use the automatic stabilizer route to manage fiscal levers. This would mean that fiscal deficit can purely go up via the automatic fiscal stabilizer route whereby a reasonable cut in fuel prices or even goods and services tax (GST) waivers for stressed entities could work wonders.

Interestingly, our analysis of over 1,000 listed entities reveal that corporates deleveraged across sectors to cut finance cost and used the bond market route to substitute high-cost debt through bond issuances. In fact, primary issuances of bond, as per CCIL, by the manufacturing sector increased to 34,764 crore in FY21 from 5,585 crore in FY20.

In the government securities market, the low levels of limit utilization by FPIs at 38.4% entails that FPIs have not taken position in government securities. RBI has now permitted authorized dealer banks to place margins on behalf of their FPI clients for their transactions in government securities (including state development loans and treasury bills) which indicates that some amount of leveraging is now permitted. This will bring the necessary additional liquidity, thus checking yields.

Continuing with its reforms on regional rural banks (RRBs), to provide greater flexibility in raising short-term funds, it has now been permitted RRBs to issue certificates of deposit (CDs) to eligible investors.

There have been some recent speculation suggesting that RBI has intervened in the forex market heavily, which facilitated the large surplus transfer 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 episodic bouts of outflows and inflows.

A clear example of RBI’s two-way intervention in the foreign exchange market could be the recent decline in one-month forward premia, because of RBI reversing the sell-buy swap transactions to buy sell swaps. In fact, a decline in forward premia is even negative for non-funded carry trade and, hence, could put upward pressure on the rupee value, that in itself is a clear two-way movement!

In all, with the second wave receding, with the possibility of a third wave, it was prudent to maintain status quo. One would expect policy accommodation to continue for the rest of the year.

Soumya Kanti Ghosh is group chief economic advisor at State Bank of India. Views are personal.

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