MPC delivers yet another off-cycle rate cut, RBI continues to provide regulatory relief
* Repo rate cut to 4%: In yet another off-cycle action, the MPC cut repo rate by 40bps to bring it down to 4%. Consequently, reverse repo and MSF now stand at 3.35% and 4.25% respectively. Interestingly, the RBI did not widen the spread between reverse repo and repo. This indicates acknowledgement by the central bank that banks are parking money with it due to high risk aversion and increasing negative carry by reducing reverse repo rate more sharply is unlikely to nudge banks to lend unless economic outlook improves.
* One MPC member votes for 25bps cut: In the last off-cycle MPC meeting during 24-27 Mar 2020, two members (Dr Ghate and Dr Dua) voted for 50bps reduction while the remaining four members voted for 75bps reduction. In the minutes, Dr Ghate noted that in a demand-deficient economy a large cut is akin to ‘pushing on a string’. His view that rate cuts may not be effective in stimulating demand in current situation seems to have remained unchanged since last policy. In this policy, he was the only member who voted for a smaller (25bps) rate cut.
* Inflation outlook highly uncertain: The CSO did not release headline CPI inflation number for April 2020 citing data collection issues amidst the lockdown. It released inflation numbers for ~53% of the basket based on a sample size that was only half of normal sample size. In the absence of sufficient information on recent price movements, it is difficult to gauge the trajectory of inflation in the near term. The MPC noted that inflation outlook was highly uncertain in FY21. It expects headline inflation to remain firm in H1FY21 and fall below target by Q3-Q4FY21. We concur with MPC’s assessment due to the following reasons: (i) hoarding and panic-buying (especially of food items) in the first couple of months of FY21 are likely to keep food inflation high at least in Q1FY21 (ii) however, as restrictions on movement are gradually lifted, the transportation and transaction costs associated with food supply chains are likely to come down. This, in addition to higher supply of food items later in the year could ease food prices (iii) we expect services inflation to ease in H2FY21 due to weak aggregate demand.
* Growth likely to contract in FY21: In his statement, the Governor added that GDP growth in FY21 is likely to remain in negative territory. Our assessment suggests that growth in Q1FY21 is likely to come in at -20% to -30%. Q2 is also likely to record growth contraction although the magnitude of the same could depend on how quickly the lockdown is lifted and in which geographies. Cumulative monetary and fiscal stimulus, along with pent-up demand entering the market starting H2FY21 could give fillip to growth. Q4FY21 could be the best quarter in terms of growth, partly due to pick up in momentum and partly due to low base. Overall, we expect the economy to contract between 4-6% in FY21.
* RBI continues to provide regulatory relief: Outside the purview of MPC, the RBI continued to provide regulatory relief to ease the financial stress caused by Covid19. In today’s policy, it announced several regulatory relief measures including extension of moratorium on term loans, deferment of interest on working capital, relaxation on Consolidated Sinking Fund of state government, measures to support exports and imports among others.
* GDP data release on 29 May 2020 will be closely watched: The CSO is scheduled to release quarterly growth numbers for Q4FY20 and provisional estimates for FY20 on 29 May 2020. Since the lockdown affected last one week of Mar 2020, the growth numbers will be keenly watched. We expect growth in Q4FY20 to come in at ~3% and growth for full year FY20 to come in at ~4.4%. These growth numbers, along with other high frequency data, will be keenly watched by the MPC to decide future trajectory of rate cuts.
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