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VIEW: RBI is not done with rate cuts

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Macroeconomic backdrop ahead of the current MPC meeting remains complicated.

VIEW: RBI is not done with rate cuts
The macroeconomic backdrop ahead of the current MPC meeting remains complicated. While India—like several other economies across the globe—is set to witness a sharp unprecedented contraction in economic activities, the latest inflation print has moved above the upper tolerance band (i.e. 6 percent) of the RBI. This has inflicted some doubt about whether the MPC will deliver yet another rate cut later this week, even though continuing with an “accommodative” stance remains certain. Also, the RBI has delivered sizeable rate cuts of late. For instance, the reverse repo rate, the key operating rate at present was lowered by over 150 basis points since late-March.
Nevertheless, one believes that the RBI is certainly not done with cutting rates. While rate action in the current policy is a relatively close call, my expectation is that of a calibrated cut in this meeting. But, importantly and irrespective of the rate action in August, one feels that the unprecedented dent in economic activities will eventually lead to further material rate cuts even from the current levels of historic lows / near-historic lows.
Inflation not a threat despite the latest print
Admittedly, the headline CPI print for the month of June came in at 6.1 percent YoY, higher than what was projected by most forecasters and above the upper tolerance band of the inflation-targeting central bank. However, one must recognise that the upside surprise in retail inflation was driven largely due to intermittent supply disruptions in various parts of the country and was far from any demand overheating. While optically even core inflation was higher, items such as precious metals made a meaningful contribution. While that feature may continue for a while, it is important for the MPC to differentiate between inflation emanating from such factors and inflation from demand-side pressure while formulating policy responses.
Most importantly, monetary policy has to be forward-looking. Despite the upside surprise in the June print, one feels that CPI inflation will likely be in the range of 3-4 percent during the larger part of H2 FY 20-21. Thus, it is important that the MPC does not lose its focus of supporting economic revival and financial stability. The RBI has done a commendable job so far to support the pandemic-hit economy and one is confident that just an intermittent upside surprise in inflation print will not alter its focus.
Further downside to growth forecasts not ruled out
On the other hand, weakness in economic activities remains stark. One of the recent RBI publications—the Financial Stability Report, released in late July— indicated that the central bank’s baseline expectation of FY 20-21 GDP is that of a mid-single-digit contraction. However, increasingly a larger number of forecasters are now fearing double-digit contraction in real GDP during the current financial year, even after taking into account the likelihood of a materially better H2 than the first six months of the year. Thus, further downside risks to the current set of forecasts cannot be ruled out.
Several high-frequency indicators of economic activities—such as PMIs, electricity demand, traffic movement, core industrial growth—recorded an encouraging uptick in June as soon as the country moved out of the strict lockdown of April and May. However, subsequently, a further uptick in activities remained slow. Importantly, the spread of the COVID-19 infections remained widespread during July-August, often resulting into short-term localised lockdowns at various parts of the country—this will likely inflict greater uncertainty and a serious headwind for economic recovery.
Fiscal support key to recovery
Revival in economic activities in the coming quarters will remain critically dependent on fiscal policy support. In that context, specific steps by the RBI as the debt manager of the government will play a critical role. One would recommend evaluating a number of potential measures in this context, such as (a) elongating the maturity profile of the government’s liabilities, especially given the current low-interest rates, (b) issuing larger quantum of securities in the benchmark 10-year bucket to ensure better liquidity in this segment, and (c) allowing greater flexibility for the held-to-maturity (HTM) books of banks. Such measures collectively can create a more conducive situation for sailing through a larger quantum of fiscal borrowing in the current year, which is clearly on the cards.
Targeted support to the bottom of the pyramid needed  
Furthermore, while the RBI has already lowered interest rates and has provided a large quantum of liquidity in recent months, one feels that targeted liquidity operations—like the TLTROs the RBI had introduced in recent months —hold the key for a quicker recovery in the coming months. In this context, one feels that it is critically important to provide focused support to the lower end of the socio-economic pyramid. While the level of stress during the lockdown period is often high for the lower strata of the economy, with meaningful and targeted policy support, these segments can potentially recover quickly once economic activities normalise and lead the recovery. We expect continued support for such segments (eg., microfinance, MSMEs, and affordable housing) from the central bank.
—Siddhartha Sanyal, Chief Economist and Head—Research, Bandhan Bank. The views expressed are personal

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