The Reserve Bank of India (RBI) has revised upwards retail inflation projection for FY 22 to 5.7 per cent from 5.1 per cent, even as it retained real GDP projection at 9.5 per cent.
The revised quarterly retail inflation projections are: 5.9 per cent in Q2 (5.4 per cent earlier projection); 5.3 per cent in Q3 (4.7 per cent); and 5.8 per cent in Q4 (5.3 per cent) of 2021-22.
“Since the start of the pandemic, the Monetary Policy Committee (MPC) has prioritised revival of growth to mitigate the impact of the pandemic. The available data point to exogenous and largely temporary supply shocks driving the inflation process, validating the MPC’s decision to look through it,”RBI Governor Shaktikanta Das said.
The Governor observed that supply-side drivers could be transitory while demand-pull pressures remain inert, given the slack in the economy.
He emphasised that a pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions.
Retail inflation print stayed above the upper band of the Reserve Bank of India’s 2-6% target for the second straight month in June, causing the stakeholders to watch its moves more intently. RBI started easing the policy rate since February 2019; it adopted ‘accommodative’ monetary policy stance in June 2019 and has since maintained it, given the grave challenge to economic growth due to the pandemic. Governor Shaktikanta Das expounds on the current priorities of the central bank, which is also the government’s debt manager, in an exclusive interview with Shobhana Subramanian and KG Narendranath.Excerpts:
Is the latest retail inflation number (6.26% in June, upon a high base of 6.23%) a cause for worry or has it come as a relief (given it eased a tad from a six-month high of 6.3% in May)? How long will the RBI be able to retain the growth-supportive bias in the conduct of monetary policy?
The CPI inflation number for June is on expected lines. The year-on-year growth in ‘core’ inflation (eased marginally to 6.17% in June compared with 6.34% in May. The momentum of the CPI inflation has come down significantly in the both headline and core inflation in June.
The current inflation is largely influenced by supply-side factors. High international commodity prices, rising shipping charges and elevated pump prices of diesel and petrol (which are partly due to high taxes) are putting pressure on input prices. Prices of several food items including meat, egg, fish, pulses, edible oils, non-alcoholic beverages have risen too.
Supply-chain constraints have also arisen out of the Covid 19 related restrictions on movement of goods, and these are easing slowly. Over the last few months, the government has taken steps to address the price rise in pulses, edible oils as also the imported inflation, but we do expect more measures from both the Centre and states to soften the pace of inflation.
Last year, in July and August, CPI inflation was in excess of 6%; in September and October, it was in excess of 7% and in November, almost 7%. That was the time when the Monetary Policy Committee (MPC) had assessed that the spike in inflation was transitory and it would come down going forward. In hindsight, the MPC’s assessment was absolutely correct. Now, the MPC has assessed that inflation will moderate in Q3FY22, so I emphasise on the need to avoid any hasty action. Any hurried action, especially in the background of the current spike in inflation being transitory, could completely undo the economic recovery, which is nascent and hesitant, and create avoidable disruptions in the financial markets.
At 9.5% (real GDP) growth projected by us for FY22, the size of the economy would just about be exceeding the pre-pandemic (2019-20) level. Given that growth is still fragile, the highest priority needs to be given to it at this juncture.
We need to be very watchful and cautious before doing anything on the monetary policy front. Also, all this we have to see in the context of the truly extraordinary situation that we are in, due to the pandemic. It is not like any other year or occasion, when inflation goes up, you start tightening the monetary policy.
The Centre’s fiscal deficit is high (the budget gap more than doubled to 9.3% of GDP in FY21 and is projected to be 6.8% this year), but given the huge revenue shortfall, the size of the fiscal stimulus is limited and not adequate to push growth. Yet, the RBI needs to focus a lot on the yield curve to ensure that the government’s borrowing cost doesn’t skyrocket. Some would say the RBI’s debt management function is taking precedence over its core function, which is inflation-targeting. Is the RBI open to creating new money to directly finance the fiscal deficit?
I would not agree with the formulation that debt management is undermining inflation-targeting. In fact, our debt management operations throughout the past year and more has ensured better transmission of monetary policy decisions. We are using the instruments at our command to ensure transmission of rates. Thanks to our debt management operations, the interest rates on government borrowings in 2020-21 were the lowest in 16 years, and private-sector borrowing costs have also substantially reduced. If the real estate and construction sectors are out of the woods now, the all-time low interest rates on housing loans have had a big role in it.
We have not only reduced interest rates in consonance with monetary policy, but have also ensured availability of adequate – even surplus– liquidity in the system through OMO, Operation Twist and GSAPs. These have resulted in lower borrowing costs and financial stability across the entire gamut of stakeholders including banks, NBFCs and MFIs, and, therefore, been very supportive to economic growth.
If you look at the M3, the growth of money is just about in the range of 9-10%, meaning our accommodative stance is not really creating high inflation.
As far direct financing of the government’s fiscal deficit is concerned, this apparently easy option is out of sync with the economic reforms being undertaken; it is also in conflict with the FRBM law. In fact, this option has several downsides and the RBI has refrained from it.
What’s important is the (high) efficiency with which the RBI is meeting the borrowing requirement of the government. The Centre and states, among themselves, borrowed about Rs 21-22 lakh crore, a record high amount in FY21, but at historical-low interest rates. In the current year too, there could be a borrowing quantum of the same order, and the RBI will use all the tools at its disposal to ensure that the borrowings are non-disruptive and at low interest rates.
There is ample liquidity in the system, yet the banks appear to be extremely risk-averse. They would rather park the excess funds under the reverse repo window, than lend to the industry. Even the government’s schemes like ECGLS – which insulates banks from credit risk on loans to MSMEs and retail borrowers – and the targeted liquidity policy of RBI for small NBFCs don’t seem to change the outlook much. As the regulator, how do you get this fear psychosis out of banks?
The banks have to do prudent lending with proper appraisals. Risk aversion on the part of the banks is arising from the current pandemic situation, and its possible consequences. Demand for credit from the industry is also not as high as one would expect it to be. This is because there is still a large output gap that constrains new investments.
Many large companies considerably deleveraged their bank loans in FY21, while raising money from the corporate bond market. So banks have to lend where there is a demand, and that is one reason why lending to retail sector is growing. There is no gainsaying that bank credit needs to rise; I’m sure banks will indeed lend if there is demand for credit and the projects are viable.
There is a lot of demand for loans from companies that are relatively low-rated. Banks are not willing to take any risk…
Of course, the risk perception (among lenders) is high and, precisely for that reason, the government unveiled the ECLGS scheme (under which guaranteed loans up to a limit of Rs 4.5 lakh crore will be extended). If you see our TLTRO scheme or the refinancing support (special facilities for Rs 75,000 crore were provided last year to all India financial institutions, including Nabard and SIDBI; a fresh support of Rs 50,000 crore has been provided for new lending in FY22), the objective is that they would lend to small and micro businesses. We have also given Rs 10,000 crore to small finance banks and MFIs at the repo rate (4%), again to ensure adequate fund flow to micro and small firms.
As for the healthcare sector, banks are allowed to park their surplus liquidity up equivalent of the size of their Covid loan books with the RBI at a higher rate. We are also according priority-sector status to certain loans for the healthcare sector. So, because of the extraordinary situation, we are incentivising the banks to lend more through a series of measures.
As the regulator, our job is to provide an ecosystem where the banking sector functions in a very robust manner. But beyond that, who the banks will lend to or won’t lend to must be based on their own risk assessment, and the prudential norms.
In the recent financial stability report (FSR), the worst-case NPA scenario after the full withdrawal of forbearance is foreseen to be better than the best case perceived in the January edition…
We had a much clearer view of the assent quality in the July FSR than when the January edition was drafted, when the regulatory forbearance partially blurred the picture. Still, these are assumptions and analytical exercises rather than projections. These could serve as guidance to the banks in their internal analysis of, say, a possible severe stress scenario. We expect the banks could use these inputs to take proactive, pre-emptive measures on two fronts specifically: increasing the provision coverage ratio and mobilsing additional capital to deal with situations of stress or a severe stress, should these happen.
These assumptions, based on real numbers, could by and large hold true, unless a third Covid-19 wave plays spoilsport.
In the auction held on Friday, you allowed the benchmark yield to go up to 6.1%, while it had long seemed you won’t tolerate a rate above 6%…
We’ve never had any fixation that the yield should be 6%, but some of our actions might have conveyed that impression. After the presentation of the Budget (for FY22) and other developments such as the enhanced government borrowing, the bond yields suddenly spiked. The 10-year G-secs, for example, reached 6.26%. But after that, through our signals and actions (in the form of open market operations, Operations Twist and G-SAP, and our actions during auctions, going sometimes for the green-shoe option or sometime for cancellations, etc) we signalled our comfort level to the markets.
So, we are able to bring down the yield and the rates, by and large, remained less than 6% till about January or so. The first auction that we did last Friday when we introduced the new-tenure benchmark reflected one important thing that the focus of the central bank is on the orderly evolution of the yield curve and the market expectations seem to be converging with this approach. So, it will be in the interest of all stakeholders, the economy, if the same spirit of convergence between the market participants and other stakeholders, and the central bank continues and I expect it will continue.
A jump in the RBI’s ‘realised profits’ from sale of foreign exchange enabled you to transfer a higher-than-expected Rs 99,122 crore as surplus to the government for the nine months to March 31, 2021. Are you sticking to the economic capital framework as revised on the lines of the Bimal Jalan committee’s recommendations?
One of the key recommendations of the committee is that unrealised gains will not be transferred as a part of surplus and we are strictly following that. We intervene in the market to buy and sell foreign currencies, and what we earn out of that are realised gains. A large part of the surplus transfer constitutes the exchange gains from foreign exchange transactions. So whatever gains we make out of this are not unrealised (notional) gains (which can’t be transferred under ECF). We also make losses in such transactions, because RBI isn’t in the game of making profit but in the game of maintaining stability of the exchange rate and ensuring broader financial stability.
Last year, about Rs 70,000 crore had to be transferred to the contingency reserve fund because it was falling short of the 5.5% level recommended by the Jalan committee. This was because our balance sheet size grew substantially last year due to liquidity operations that we undertook in March, April and May. So, last year the larger size of the RBI’s balance sheet required that as much as Rs 70,000 crore be transferred to the contingency reserve fund. This year, the expansion of balance-sheet wasn’t that much, so the transfer was much less at about Rs 25,000 crore.
Government Securities (G-Sec) prices dropped on Tuesday as the retail inflation reading for May 2021 spiked above the monetary policy committee’s upper tolerance threshold of 6-6.30 per cent against 4.2 per cent in April.
Given that MPC tracks the retail (consumer price index/ CPI-based) inflation gauge closely, if the reading sustains above the 6 per cent mark for another month or two, it will have to do a hard re-think on its ultra-loose monetary policy to tamp down inflation.
Price of the 10-year G-Sec (coupon rate: 5.85 per cent) came down by about 26 paise to close at ₹98.64 (previous close: ₹98.895), with its yield rising 4 basis points to 6.04 per cent (previous close: 6.00 per cent).
Price and yield of bonds are inversely related and move in opposite directions.
‘Double whammy’
Madan Sabnavis, Chief Economist, CARE Ratings, said, “The CPI inflation number at 6.3 per cent is higher than our expectation of 4.9 per cent and is a kind of double whammy for the economy coming as it does over a sharp increase in WPI (wholesale price index-based inflation) by 12.9 per cent.”
He emphasised that high CPI inflation will be a concern for the Reserve Bank of India (RBI) as it is higher than their estimate of 5 per cent.
“Though the stated policy is that growth is more important, which means that repo rate will not be touched, it will be a nagging issue nevertheless especially if inflation remains in this region. We expect it to be around 5.5-6 per cent in next couple of months,” Sabnavis said.
Price of the G-Sec maturing in 2026 (coupon rate: 5.63 per cent) fell 42 paise to close at ₹99.94 ( ₹100.36), with its yield rising about 10 basis points to 5.64 per cent (5.54 per cent).
Price of the G-Sec maturing in 2035 (coupon rate: 6.64 per cent) too declined 42 paise to close at ₹99.94 (₹100.36), with its yield rising about 4 basis points to 6.64 per cent (6.60 per cent).
Suyash Choudhary, Head – Fixed Income, IDFC AMC, observed that the May CPI print will likely on the margin push up the importance of inflation in the growth versus inflation trade-off for RBI.
“This doesn’t necessarily mean that the central bank will start to respond to this right-away. However, the bond market may step up speculation with respect to the shelf-life for RBI’s current ultra-dovishness.
“This may make the task of dictating yields to the market that much more difficult for the central bank. At any rate, in our base case view, RBI would have started to dial back on its level of intervention at some point and we were budgeting for a gradual rise in yields overtime,” he said.
Reserve Bank of India Governor Shaktikanta Das-headed rate-setting panel MPC started its three-day deliberations on the next monetary policy on Monday amid a sudden surge in Covid-19 cases and the government’s recent mandate asking the central bank to keep retail inflation around 4 per cent.
The RBI will announce the resolution of the Monetary Policy Committee (MPC) on April 7.
Experts are of the view that the RBI will maintain status quo on policy rates at its first bi-monthly monetary policy review for the current fiscal. It is also likely to maintain an accommodative policy stance.
The policy repo rate or the short-term lending rate is currently at 4 per cent, and the reverse repo rate is 3.35 per cent.
Last month, the government had asked the RBI to maintain retail inflation at 4 per cent with a margin of 2 per cent on either side for another five-year period ending March 2026.
M Govinda Rao, Chief Economic Advisor, Brickwork Ratings (BWR), said given the rise in the spread of coronavirus infections and the imposition of fresh restrictions to contain the virus spread in the major parts of the country, RBI is likely to continue with its accommodative monetary policy stance in the upcoming MPC meeting.
“Considering the elevated inflation levels, BWR expects the RBI MPC to adopt a cautious approach and hold the repo rate at 4 per cent,” Rao said.
Rao noted that in the last MPC, RBI initiated measures towards the rationalisation of excess liquidity from the system by announcing a phased hike in the cash reserve ratio (CRR) for restoration to 4 per cent.
“In the current scenario, the RBI may like to drain in excess liquidity, while higher borrowings and the frontloading of 60 per cent borrowings in H1 FY21 may put pressure on yields, and hence, the RBI may go slow in reversing its liquidity measures announced as a Covid-19 stimulus since March 2020,” Rao added.
Meanwhile, G Murlidhar, MD and CEO, Kotak Mahindra Life Insurance Company, said 2021 has seen a rise in yields across the globe in line with the vaccination-led optimism.
“However, the case for India is a little different this time, with a rapid rise in new Covid-19 cases over the last few weeks. In the upcoming policy, MPC may continue to emphasise the importance of ‘orderly evolution of the yield curve’ given benign inflation trajectory and second wave headwinds to nascent growth recovery,” said Murlidhar.
In a bid to control the price rise, the government in 2016 had given a mandate to RBI to keep retail inflation at 4 per cent, with a margin of 2 per cent on either side, for a five-year period ending March 31, 2021.
The central bank mainly factors in the retail inflation based on Consumer Price Index while arriving at its monetary policy. On February 5, after the last MPC meet, the central bank had kept the key interest rate (repo) unchanged citing inflationary concerns.
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