RBI Monetary Policy: Economists See Small Rate Cuts, Unconventional Measures Ahead
Shaktikanta Das, governor of the Reserve Bank of India (RBI), pauses during an interview at the central bank in Mumbai, India, on Tuesday, March 3, 2020. (Photographer: Kanishka Sonthalia/Bloomberg)

RBI Monetary Policy: Economists See Small Rate Cuts, Unconventional Measures Ahead

India’s Monetary Policy Committee has cut its benchmark repo rate by another 40 basis points, taking the total quantum of rate cuts to 115 basis points since the Covid-19 crisis hit India.

The repo rate now stands at a record low of 4%, while the reverse repo rate, at 3.35%, is 10 basis points above its record low. While interest rates were on a downward trajectory even before the global and local economy was hit by fallout of the pandemic, the pace of rate cuts has steepened now.

Cumulatively, since December 2018, the repo rate is down by 250 basis points.

RBI Monetary Policy: Economists See Small Rate Cuts, Unconventional Measures Ahead

Room For Another 50 Basis Points?

Despite the steep reduction in rates already, there may be more to come. The MPC, on Friday, maintained an accommodative stance and said that scope for further monetary policy easing may open up as inflation eases against the backdrop of an extremely weak economy.

While the MPC did not forecast growth for the year, RBI Governor Shaktikanta Das said full year growth is likely to be negative. Given the wide output gap, the MPC may cut rates again.

“We believe the central bank still has room to cut rates further,” said Rahul Bajoria, chief India economist at Barclays. “We continue to expect another 50 basis points of rate cuts, most likely to be delivered by end-June or early-July,” Bajoria said. “This keeps our projection of terminal repo rate at 3.5%, with risks clearly biased towards rates going further lower.”

Suvodeep Rakshit, senior economist at Kotak Securities, expects the MPC to cut rates by another 25-35 basis points. The quantum of rate cuts may go up to another 50 basis points, he said.

“We expect further support from the central bank in the form of another 50 basis points cut in the repo rate amidst widening of negative output gap and assertion of disinflationary pressures,” said Vivek Kumar, senior economist at Yes Bank. Kumar pointed out that real interest rates in India are already at zero and could go down to -0.5 percent if the MPC cuts rates again.

Among key EM countries, barring Turkey, India already has the lowest real monetary policy rate. Any aggressive direct monetary easing would make it further negative, thereby creating disincentives for domestic savings while creating pressure for the currency from an external perspective.
Vivek Kumar, Senior Economist, Yes Bank
RBI Monetary Policy: Economists See Small Rate Cuts, Unconventional Measures Ahead

Space for more easing is less than is apparent from policy rates, said Sajjid Chinoy, chief India economist at JP Morgan. Chinoy expect another 25 basis point cut in the repo rate and a 35 basis point cut in the reverse repo rate at or before the August policy review.

Chinoy explains that given the level at which operative inter-bank rates are trading, there may be limited room for the MPC to cut further.

Given the glut of inter-bank liquidity, currently at Rs. 7.2 lakh crore, the operative interbank rate (TREPS) has averaged 3% over the last month, thereby trading 75 basis points below the reverse repo rate of 3.75% . With the reverse repo now cut to 3.35%, the TREPS rate is likely to more consistently trade in the 2% handle, especially as the inter-bank liquidity surplus is only expected to get larger. This could limit the effective space the RBI has to cut policy rates in this cycle. 
Sajjid Z. Chinoy, Chief India Economist, JP Morgan

Chinoy added that the RBI may like to keep some gunpowder dry for the future, given the unprecedented uncertainty that the world is grappling with. “Today’s 40 basis points cut – which may have underwhelmed market expectations – needs to be seen against that backdrop.”

Conventional-Unconventional Mix

Economists and fixed income managers expect the RBI to work with a mix of conventional interest rate easing, along with more unconventional liquidity and regulatory measures.

“Traditional easing is now rapidly diminishing in utility and effectiveness as it is not able to solve for either the substantial steepness of the curve or the higher levels of spreads on lower rated issuers,” said Suyash Choudhary, head of fixed income at IDFC Mutual Fund. “Both are reflective of inadequate availability of deployable risk capital in the system.”

Choudhary said the RBI may have to “turn more proactive both on intervention and incentivisation” to ensure that the large government borrowing programme doesn’t lead to even wider term premia. “It is on this count that the bond market will be generally disappointed yet again for now.”

According to Kumar, the RBI could come up with a large scale bond purchase program (via OMOs) covering both government securities and state development loans to lower elevated term premium and credit spreads in the economy.

Rakshit said the next set of announcement may be more focused on rising bad loans of the banking sector, incentivising credit to stressed sectors and deficit monetisation. The measures, from hereon, should be more sector specific along with the usual measures which ensure macro prudential stability, said Rakhit.

Also Read: RBI Extends Loan Moratorium By Three Months Till Aug. 31

Pranjul Bhandari, chief India economist at HSBC, also said measures such as a loan restructuring scheme for banks, revisiting the idea of a bad bank, particularly for the real estate and power sector, and infusing capital in banks may be next steps for the RBI to consider.

Sonal Varma of Nomura also said that the real policy punch needs to come from unconventional measures. While the policy easing is welcome, the effectiveness of rate cuts and excess liquidity on delivering the “growth bang” is incrementally diminishing in a scenario of rising credit risk aversion, she said.

While we expect the RBI to deliver more easing (50 basis points more of repo rate cuts vs our earlier forecast of 35 basis points), the real policy punch needs to come from unconventional monetary policy to navigate around the balance sheet issues.
Sonal Varma, Chief India Economist, Nomura
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