RBI Policy: Who expects what from the Monetary Policy Committee

Cogencis, Friday, Jul 31, 2020

NEW DELHI – The following are the expectations of economists from the Reserve Bank of India's Monetary Policy Committee at its second meeting for 2020-21 (Apr-Mar). The three-day meeting commences on Tuesday, with the decision to be announced on Thursday.


…given the time it takes for policy rate cuts to translate into lower borrowing costs and the uncertain state of the economy, we believe RBI will ease policy by cutting both the repo and reverse repo rates at least 25 basis points to 3.75% and 3.10%, respectively. We still see the terminal repo rate as being 3.50%, which we now believe will be reached in Oct-Dec, instead of Jul-Sep.

In terms of the divide within the MPC, we see scope for more diverse views, as some MPC members may voice their concerns, a development that could lead to a tempering of enthusiasm for material front-loaded policy support from here on. Still, we see the likelihood of any shift from an accommodative policy stance as unlikely and too early.


…since the last MPC meeting in May, the scale of the economic damage caused by the lockdown has become more apparent. The collapse in the latest activity data suggests that there was an almighty economic contraction in Apr-Jun…And despite the recent gradual lifting of containment measures, the economic recovery is likely to be slow and protracted.

Given the severity of the economic downturn, there is a strong case for policy to be loosened further.


…the rate-cutting cycle might slip into a temporary pause in August. The RBI will be in a tough spot due to overarching weakness in growth, nonetheless, a pause on rates is also backed by cumulative 115 bps cut since January, above-target inflation, high-frequency indicators improving at the margin, and concerns over inflationary expectations. As supply-issues iron out given opening up of inter-state movement and growth-driven disinflationary forces assert themselves, rate cuts become a matter of 'when' not 'if'. We expect 50 bps of cuts in Jul-Dec as downside risks to growth continue to mount. Marginal utility of successive rate easing is, however, falling, given the undercurrent of risk aversion in the domestic financial sector and weak credit growth.


The popular narrative on inflation is that the rise is due to a COVID-19-led supply shock…And yet, for three good reasons, inflation may need closer monitoring now than in the recent past: One, real rates, which have been a driver of inflation in the past, are moving towards the negative terrain after six long years. Two, there are risks that inflation expectations could get unanchored, particularly if their being anchored over the last few years was contingent on other factors such as real rates being positive. Three, to avoid further supply disruption, viable firms may need to be kept afloat with adequate credit; but the banking system, unfortunately, is rather risk averse, and may not fully oblige.

After cutting rates by 115 bps over two consecutive policy meetings, we think the RBI will pause in the upcoming Aug 6 meeting. It is also likely to revise up its inflation forecast for the year. Having said that, we expect it to hold on to an accommodative stance and continue to keep domestic liquidity at surplus.

If activity remains subdued and the seasonal spike in vegetable prices reverses over the next few months, the RBI is likely to cut rates in Oct-Dec.

We hold on to our forecast of 50 bps further easing in the remainder of the cycle. While this remains our base case, if the sequential momentum in inflation does not decline as rapidly as expected, we could see a more moderate easing of 25 bps.


ICRA expects the MPC to look through the above-target inflation readings, and further ease policy rates during the upcoming policy review, as the nascent recovery in certain economic indicators appears to be faltering, and the timing is opportune for swift transmission of rate cuts.

We anticipate a further asymmetric cut of 25 bps in the repo rate and 35 bps in the reverse repo rate, in a split decision from the MPC. Moreover, we wait for its assessment of the space for further easing.

Since the May policy review, the outlook on the economy and the real sector has only worsened. Although the CPI inflation has exceeded the MPC's target range of 2-6% for three consecutive months in the lockdown and initial unlock period, we expect it to recede within this range by August. With liquidity remaining in substantial surplus, we expect the banking system to rapidly transmit additional rate cuts, thereby supporting the case for front loading of policy easing.


The MPC is likely to be on hold, waiting for supply disruption driven food price pressures to subside on easing of movement restrictions and to assess the extent of demand weakness and growth contraction with its impact on inflation over the next one year. More importantly, with money market rates aligned closer to reverse repo rate of 3.35%, instead of the policy repo rate of 4.00% on the back of large durable liquidity surplus, the effective easing has been almost 180 bps. That is more than the policy rate easing of 115 bps. The MPC members can, therefore, wait-and-watch until the next meeting in October.


While the near term inflation readings have surprised on the upside, we continue to expect the Oct-Mar inflation trajectory to remain benign amidst favourable base effect and a more permanent impact of demand side contraction weighing on core inflation. We see room for 25 bps rate cut with a possible pause thereafter as the MPC has mostly frontloaded its policy rate cuts decision to aid the economy. We, however, see higher probability of a widening of the policy corridor to 75 bps, with a reverse repo cut of 35 bps as RBI continues its efforts towards transmission.


I think the MPC will maintain a status quo on rates. If you see the yield curve, there has been greater transmission at the shorter-end. And talk of the government borrowing even more from the market is weighing. That nervousness will not be reduced by cutting the policy rate. The MPC will have to gauge the effectiveness of a rate cut and I don't think it serves a purpose right now. The confidence of lenders has to be improved and a rate cut won't do that. So the RBI will probably take measures to improve the comfort of the banking industry.


I still have a 50-bps cut pencilled in. Inflation has been a little bit more elevated than expected, but we think in the upcoming months it will continue to level off, based on lower-trending core inflation. Moreover, the interest rate spread vis-a-vis the US Fed funds target rate is still above 3 percentage points, which opens up possibilities for the RBI to cut.

What is important here is that there are not much more other policy options on the table. For one, the government has little room to manoeuvre. Currently, we think India's central government budget deficit will end up being 6.9% for calendar 2020 without a marked improvement in subsequent years. Additional measures could induce rating agencies to downgrade the sovereign.


We do not expect another repo/reverse repo rate cut in August policy, in a close call. In our view, markets including us will be vigilant on measures if any to improve the transmission of the monetary policy easing. The statement is likely to be dovish to assure the markets of lower rates for longer as any indication of worries around inflation can push market yields higher and inhibit the process of policy transmission.

We do expect the MPC to acknowledge the recent spike in inflation above 6%. However, we expect them to emphasise on likely cooling of inflation below 4% in Oct-Mar, as supply disruptions in food markets ease. We maintain our call of another 50 bps rate cut in Oct-Mar, as growth worries persist.


…we believe an August rate cut is unlikely. With the 115 bps reduction in repo beginning February, banks have already transmitted 72 bps to the customers on fresh loans in the interregnum which is perhaps a milestone in terms of the fastest policy rate transmission in India. Large banks have transmitted as much as 85 bps. This has happened because of a proactive RBI using liquidity among others as a tool to serve its policy objective. We believe that the MPC could now well debate what further unconventional policy measures could be resorted to in the current circumstances to ensure financial stability is continued to be addressed.  End

Compiled by Siddharth Upasani

Filed by Michael Correya

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