The Monetary Policy Committee (MPC) will meet to deliberate in the first week of August 2020, with the economy facing a recession and the need to control inflation expected to have their mission cut off. In addition to a slew of RBI stimulus initiatives such as CRR reduction and open market purchases, the MPC has also announced 115 bps repo rate cuts and launched new liquidity tools such as long term repo operations (LTRO) to help the economy and balance markets in these turbulent times. The pandemic and resulting shutdown have simultaneously affected supply and demand, lowered market trust, and raised risk avoidance.
Global production is expected to decrease by 4.9 percent in CY2020, with India experiencing a reduction of 4.5 percent, according to IMF projections. Renewed spike of COVID-19 cases worldwide leads to sluggish markets opening up and slow recovery by 2021.
Huge fiscal and monetary aid to counter the pandemic-induced lockdowns has been taken from around the world. India has implemented a stimulus of about 10 percent of GDP, but there have been minimal direct fiscal initiatives. To boost economic recovery RBI has ensured lower rates and strong liquidity so far. However, the latest high inflation figures rising cause a rethink within the MPC, while worries about growth continue to be at the forefront with GDP growth expected to contract in FY2021.
A few MPC members noted at the last policy meeting that current high inflation could cool in 2HFY2021 based on supply chain reconstruction, good monsoons, low oil prices and weak demand clogging core inflation, and should, therefore, remain focused on development. Several leaders of the MPC claimed that strategies to tackle inflation need to be implemented frontally and vigorously, but also to stimulate the economy as demand returns. The pandemic war is expected to be a long-drawn one, and will entail future government measures.
August policy is expected to witness a tug of war amid fears about development and inflation. Since the MPC still has front-loaded rate reductions, there is a chance to delay.
Debt markets in the early part of FY2021 were unpredictable as they adapted to uncertainties of the lockdown. Sustained RBI intervention on rates and liquidity helped markets during the early lockdown period for market adjustment to the “new normal”. Higher government borrowing (additional Rs 4.2 lakh crore in FY2021) continues to push government bonds.
After the last rate cut in May, government bonds have been sluggish, as market participants anticipated further intervention from RBI to encourage incremental funding in the form of open market purchases or twist operations.
Over the last few months, mutual funds have seen strong inflows particularly over gilt funds and funds invested in AAA papers of high quality. In the last few years, creditors have been more mindful of protection following credit scares. Although monetary policy may generate short-term volatility, fund flows are a function of the pattern of asset allocation and overall market liquidity of the investors.
