4th Dec ‘20

Accommodative Stance to Continue But Rate Cut Cycle is Stalled

Rates & Policy Stance Unchanged
The RBI policy announcement has left the repo rate unchanged at 4%, and it has decided to continue with the
accommodative stance of the policy as long as it is needed. This is quite in line with what market participants
expected from the RBI. The potential for inflationary pressures has also received attention from the RBI while
persisting with the current monetary stance. It is interesting to look at the RBI perspective on growth and
inflation.

“The MPC is of the view that inflation is likely to remain elevated, barring transient relief in the winter
months from prices of perishables. This constrains monetary policy at the current juncture from using the
space available to act in support of growth. At the same time, the signs of recovery are far from being broad-
based and are dependent on sustained policy support. A small window is available for proactive supply
management strategies to break the inflation spiral being fuelled by supply chain disruptions, excessive
margins, and indirect taxes. Further efforts are necessary to mitigate supply-side driven inflation pressures.
Monetary policy will monitor closely all threats to price stability to anchor broader macroeconomic and
financial stability.”

Inflation may remain elevated....

“Crude oil prices have picked up on optimism of demand recovery, continuation of OPEC plus production cuts
and are expected to remain volatile in the near-term. Cost-push pressures continue to impinge on core
inflation, which has remained sticky and could firm up as economic activity normalises, and demand picks up.
Taking into consideration all these factors, CPI inflation is projected at 6.8 per cent for Q3:2020-21, 5.8 per
cent for Q4:2020-21; and 5.2 per cent to 4.6 per cent in H1:2021-22, with risks broadly balanced.”

Economic Growth likely to recover...

“Consumers remain optimistic about the outlook, and business sentiment of manufacturing firms is gradually
improving. Fiscal stimulus is increasingly moving beyond being supportive of consumption and liquidity to
supporting growth-generating investment. On the other hand, private investment is still slack and capacity
utilisation has not fully recovered....... Taking these factors into consideration, real GDP growth is projected
at (-)7.5 per cent in 2020-21: (+)0.1 per cent in Q3:2020-21 and (+)0.7 per cent in Q4:2020-21.......”

Perspectives
An reasonable inference that could be made out of the current policy is that probably we have come to the
last leg of the rate cut cycle with the RBI accepting that the higher levels of inflation leaves little or no space
as of now for any rate adjustments. With huge inflows from the overseas investors the liquidity conditions in
the domestic market will remain in surplus. But it is expected that RBI may act to regulate the liquidity build
up in the short-term money market by enhancing the liquidity sterilization actions. These inflows will help the
RBI in the debt management for the government. Despite all the favourable factors the pick-up in credit
mainly on the corporate side is slow, though retail credit is gradually improving.

The RBI policy announcement reflects the determination of the central bank to continue with the
accommodative policy, with the base rate unchanged at 4%, while being cautious about the inflationary
pressures that are building up. But growth gets the priority once again, with inflation projected to be lower in
Q4FY21 and H1FY22. That all the liquidity measures initiated earlier will continue to be in force, is a
consolation, especially in a high inflation scenario. The growth projections too mirror the gradually improving
ground conditions, with the overall growth for this year put at -7.50%, with mildly positive growth for Q3 and
Q4. The features and contents of the policy gives the reassurance that lower rates and the plenty in liquidity
will continue for a longer time period, till the time inflation rises so much as to derail it. The policy is
supportive of both equity and fixed income markets, with its moderating implications for rates. Given the
surge in inflation and the probability of a rate cut remaining very slim, the gains from here on may be more
based on prevailing market yields rather than mark-to-market gains from debt investments. Investors would
be advised to continue to maintain investments at the shorter end of the yield curve.

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