Policy is accommodative, but shadows of selective tightening emerge…

The RBI released its own budget-like document, wherein it reiterated its commitment towards an accommodative policy to support growth and also came out with supportive measures to ensure flow of liquidity to segments of the economy immediately in need of it. In this context, while on the one hand RBI announced phased restoration of CRR to pre-pandemic levels and on the other gave relaxation of deduction of credit disbursed to ‘New MSME borrowers’ from their NDTL for calculation of CRR. The additional measures focused on the strengthening of the financial systems as well. As the economy is treading out of the unprecedented slowdown induced by the pandemic, the monetary policy is also gradually moving towards normalisation. We believe the normalisation of monetary policy is a step in the right direction, given the fact that policies effected during the times of extreme stress may lead to systemic risks in the future and also reduces the available fire power at hand to address future economic eventualities.

The Policy Action:
The RBI kept the base rate unchanged, with the repo rate at 4%, and committing to an accommodative policy till growth sustains itself. But there are shades of rationalizing the liquidity management in the policy. The hike in CRR by 1%, to be implemented in two phases, takes the CRR back to the pre-pandemic level of 4%. Any CRR measure will have an impact on the credit multiplier. This is a measure which will have an impact on the cost of credit, with the 0.50% becoming effective from March 27, 2021. Lending by banks and also their borrowings will become more expensive, if they were to focus on safeguarding margins. It also has implications for the quantum of liquidity because to the extent of the hike in CRR, equivalent amount of money, by way of a certain percentage of the net time and demand liabilities of the banks, will go into the RBI. To that extent, liquidity will get curtailed. To state this more directly, this measure will have an impact on the cost of borrowing of the corporates as well as other borrowers.

Some of the other key developmental and regulatory policies which are part of the monetary policy statement are as follows:

  • Inclusion of NBFCs to avail on tap TLTRO scheme.
  • Extension of MSF relaxation by six months to Sept’30, 2021. This dispensation provides increased access to funds the extent of ₹1.53 lakh crore.
  • Extension of the dispensation of enhanced HTM of 22 per cent up to March 31, 2023 to include securities acquired between April 1, 2021 and March 31, 2022.
  • Banks will be allowed to deduct credit disbursed to ‘New MSME borrowers’ from their net demand and time liabilities (NDTL) for calculation of CRR.
  • Capital conservation Buffer (CCD) of 0.625% and Net Stable Funding Ratio (NSFR) differed till 1st Oct 2021.
  • It is proposed to permit resident individuals to make remittances to IFSCs for investment in securities issued by non-resident entities in IFSCs.
  • Allowing retail investors to open gilt accounts with RBI.
  • FPI investment in defaulted corporate bonds will be exempted from the short-term limit and the
    minimum residual maturity requirement under the Medium-Term Framework.

The Implications: The RBI has kept the repo rate unchanged and the overall stance on provision of liquidity unchanged. This means that the anchoring of the policy to the basic accommodative stance remains unchanged. It is common knowledge that there has been excessive liquidity in the system, and there has not been any furious take off in credit demand. Due to these two factors, there may not be any major impact which the CRR changes would entail at this juncture. But one needs to be cognizant of the fact that over a period of time, as growth picks up, there may be gradual unwinding of the liquidity support extended by the RBI to the banks.

1. More Room for Held to Maturity
In Sept. 2019, the RBI increased the investments permitted to be classified as Held to Maturity (HTM) from 19.5% to 22% of NDTL in respect of SLR securities acquired on or after September 1, 2020 up to March 31, 2021. To provide certainty to banks as regards their investments and for orderly market conditions, the enhanced HTM limit of 22% has been extended up to March 31, 2022 for securities acquired between September 1, 2020 and March 31, 2021. This will help banks to acquire and hold securities, and also plan the investment portfolio in a manner which is comfortable for the bank.

2. Inflation Outlook:

(i) Food Inflation: RBI views inflation as under control and could also moderate to some extent. Several reasons have been given for this, (a) In the January 2021 round of the Reserve Bank’s survey, inflation expectations of households softened further over a three month ahead horizon in tandem with the moderation in food inflation; one year ahead inflation expectations, remain unchanged, (b) the larger than anticipated deflation in vegetable prices in December bringing down headline closer to the target, it is likely that the food inflation trajectory will shape the near-term outlook, (c) bumper kharif crop, prospects of a good rabi harvest, larger winter arrivals of key vegetables are factors that may be in favour of lower prices.

(ii) Non-Food Inflation: Price pressures may come from persistently high price pressures in respect of pulses, edible oils, spices and non-alcoholic beverages. High commodity prices and crude oil prices may also pose a threat, though the crude oil futures curve is downward sloping since December 2020. Escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices, increased pass-through to output prices as demand normalises also could exert pressure.

3. Growth Outlook: The RBI’s outlook is quite sanguine as it expects rural demand to remain resilient and the urban demand should improve as well with the substantial fall in COVID-19 cases and aggressive roll out of vaccination. With regard to GDP growth estimates the policy statement states that, “The Union Budget 2021-22, with its thrust on sectors such as health and well-being, infrastructure, innovation and research, among others, should help accelerate the growth momentum. Taking these factors into consideration, real GDP growth is projected at 10.5 per cent in 2021-22 – in the range of 26.2 to 8.3 per cent in H1 and 6.0 per cent in Q3.”

Investment Preferences: The first steps towards normalisation of monetary measures would be pertaining to liquidity rationalisation and that may lead to some movements in the market yields. The January 11, 2021 reinstatement of variable reverse repo auctions was perceived as reversing of accommodative stance, which was reflected in sharp movement in yields, especially at the shorter end of the yield curve. While the policy rate may remain stable for an extended period, till the time stance explicitly remains growth supportive, the volatility in yields cannot be ruled out. The pick-up in economic growth, and its reflection in improving credit growth, may put pressure on borrowing and lending rates of banks. The longer end of the yield curve witnessed upward pressure post the budget announcement. The high level of borrowing in FY22 coupled with an elongated timeline towards fiscal consolidation pushed the yields at the longer end higher. With the RBI not giving any guidance in terms of any OMO calendar, the yields remain at elevated levels post-policy announcement as well. Having said that, RBI remains committed to “orderly completion of the market borrowing programme in a non-disruptive manner” in its role as banker to the government. The shorter end of the curve will take guidance from the evolving liquidity situation and the longer end of the curve from the RBI’s market operations.

Given the enhanced volatility that may be experienced due to evolving growth-inflation dynamics, in the shadow of a heavy borrowing calendar and normalising monetary policy, it would be advisable to maintain discipline in terms of selection of product categories in line with investment horizons. We maintain our investment stance of focusing investments at the short to mid segment of the yield curve in Corporate Bond, Banking & PSU and Short Term funds with an investment horizon of 3 years. The longer end of the yield curve can be avoided, as higher duration leads to higher mark-to-market impact.



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