Monetary Policy December 2020 Review

As we entered December, the last month of 2020, The Monetary Policy Committee (MPC) presented its fourth bi-monthly monetary policy for the current financial year today. As anticipated by me, MPC maintained the status quo, left the policy rates unchanged, and continued the accommodative stance counterintuitive to the growing inflationary pressure.

Essentially it was the second policy meet for the newly formed MPC. All the members voted for maintaining the status quo on the monetary policy.

The policy decision by RBI has factorially attributed the slow and nascent signs pointing to an impending recovery. The acknowledgment of it not being broad-based was also served along with the acknowledgment of Price pressure dominating and maiming the domestic economy in a much severe manner than anticipated by many economists. Institutes and people. The Reserve bank of India expects a faster economic recovery. Also, it has revised upwards its GDP Outlook( No surprises there) for FY21. But the Inflation outlook turned adverse, anchoring the RBI. to raise the outlook on price levels.

Key announcements included

• Policy repo rate unchanged at 4%.
• Reverse repo unchanged at 3.35%, MSF and bank rate maintained at 4.25%.
• Accommodative policy stance to continue as long as necessary, i.e.into FY22.
• OMO purchases and operation twist to be used from time to time. Upward revision in GDP growth for FY21 to -7.5% (from -9.5%).
• The inflation outlook has hardened from earlier expectations.
• Extended liquidity support to 26 stressed sectors

Economy assessment:

• Global Economy:  Europe suffered a massive surge in covid 19 infections. The pandemic lockdown clouded the growth outlook for Q4 2020 in countries/major economies like the United States and others, the only rise to optimism. Was contributed by the progress on COVID-19 Vaccine. Though the world trade had rebound due to the easing of lockdown and is likely to slow down due in Q4 due to the exhaustion of the pent-up demand, inventory restocking completed, and rise. In uncertainties pertaining to Trade. Retail Inflation( CPI) remained muted across all AEs( advanced economies). At the same time, it did pick up in a few EMEs on firming. Food prices and supply disruptions. Global Financial markets remain afloat backed up highly accommodative. monetary policies and positive sentiments on the vaccine front

• Indian Economy 
• The domestic economy contracted by 7.5% in Q2 FY21. In Q3 FY21, various high-frequency indicators point to a recovery gaining traction. Unlike the favorable growth in October, November witnessed a moderation in some indicators. The agricultural outlook remains bright, with Rabi sowing this year being higher as compared to last year, supported by soil moisture and reservoir conditions.
• CPI inflation on the rise (from 7.3% in Sept further to 7.6% in Oct’20) with evidence of price pressures spreading.
• Domestic Financial conditions were nothing to worry about in October-November. The systemic liquidity continues to be in a large surplus. Non-food credit growth accelerated to positive territory for the first time in Nov'20 on a financial year basis. Corporate bond issuances have been higher at Rs. 4.4 lakh crore during April-October 2020 as against Rs.3.5 lakh crore during the same period last year. India’s foreign exchange reserves were US$ 574.8 billion (as of November 27), up from US$ 545.6 billion on October 2.

OUTLOOK ON INFLATION AND ECONOMIC GROWTH

• INFLATION
• Outlook turned worse than the previous anticipations
• Supply-side disruptions are pushing consumer prices up.
• Although cereal prices are expected to soften with Kharif harvest arrival and vegetable prices to ease with the winter crop, other food prices remain at elevated levels.
• Crude prices have risk on the pseudo optimism of demand recovery, OPEC+Production cuts are expected to be volatile in the near term.
• Core inflation could firm up as economic activity normalizes and demand picks up.

CPI inflation. which I expect to be could be around 5.5% by March 

• GDP Growth
• Economic recovery gaining pace has become a bullish sentiment. 
• Rural demand recovery is expected to strengthen more and urban demand is also gaining momentum with the unlocking led pickup in activity and employment.
• Concerns over a possible rise in infections in some parts of the country, prompting some local containment measures.
• Private investment, however, continues to be subdued, and capacity utilization yet to recover fully. The latest RBI data for Q1 shows a utilization level of 47.3%.
• Business-wise sentiments of manufacturing firms are improving at a snail mail pace.
• Demand for services is likely to remain subdued for some time due to social distancing norms and risk aversion.

I expect the GDP growth in Q3 to be marginally negative and turn positive only in Q4.

Policy measures- Development and Regulatory

1. Liquidity Measures to revive activity

1.1 On Tap TLTRO- Extension of sectors and synergy with ECLGS 2.0:

• Twenty-six stressed sectors identified by the Kamath Committee and the health sector to be bought within the ambit of sectors eligible under on tap TLTRO.
• Liquidity availed by banks under the scheme to be deployed in corporate bonds, commercial papers, and non-convertible debentures issued by the entities in specific sectors over and above the outstanding level of their investments in such instruments as of September 30, 2020.
• The liquidity availed under the scheme can also be used to extend bank loans and advances to these sectors.
• Investments made by banks under this facility will be classified as held to maturity (HTM), even above the 25 percent of total investment permitted to be included in the HTM portfolio.
• All exposures under this facility will also be exempted from reckoning under the extensive exposure framework (LEF). 

Aligning the TLTRO with an emergency line of credit with government guarantee is a good step for banks, enabling them to take money from RBI under the TLTRO and use these funds for lending to these sectors as identified by the Kamath Committee and also get a guarantee from the government based on the terms of the scheme.

1.2 Facilitating More Efficient Liquidity Management for Regional Rural Banks (RRBs)

• Extend LAF (liquidity adjustment facility) and MSF(Marginal Standing Facility) to RRBs
• RRBs permitted to participate in the Call/Notice money markets as both borrowers and lenders

2.Regulation and Supervision 

2.1 Dividend Distribution by banks 

Scheduled commercial banks (SCBs) and cooperative banks shall not make any dividend payouts from profits pertaining to the financial year 2019-20.

Fun fact: For FY20, out of the 12 PSBs, 7 had negative PAT, and only 5 had positive PAT of around Rs 16,500 crore. With the government being the main shareholder, the non-tax revenue will get affected. The non-tax revenue in the form of a dividend from RBI and banks and FIs was to be around Rs 90,000 crore this year, and any distribution would have helped. Further, 15 of the 18 private sector had positive PAT of around Rs 50,000 crore from which there would be no dividend paid.

2.2 Dividend Distribution policy for NBFCs: Guidelines on dividend distribution by NBFCs to be formulated.

2.3 Discussion Paper on Scale-based Regulatory Framework for NBFCs: To review the regulatory framework in line with the changing risk profile of NBFCs.

2.4Strengthening Audit Systems of Supervised Entities

Guidelines to be issued to large UCBs and NBFCs on the adoption of RBIA (Risk Based Internal

Audit).

2.5Digital Payment Security Controls

Reserve Bank of India (Digital Payment Security Controls) Directions, 2020 to be issued for

regulated entities to set up a robust governance structure for such systems and implement common minimum standards of security controls for channels like internet mobile banking, card payments, among others

2.6 Financial Literacy and Education

Expand the reach of the Centres for Financial Literacy (CFLs) to every block in the country

in a phased manner by March 2024.

2.7Grievance Redress Mechanism in Banks

Put in place a comprehensive framework comprising enhanced disclosures on customer

complaints by the banks, a monetary disincentive in the form of recovery of the cost of redress of complaints from banks when maintainable complaints are comparatively high, and undertaking an intensive review of grievance redress mechanism and supervisory action against banks that fail to improve their redress mechanism in a time-bound manner.

3.Deepening Financial Market 

• Review of Credit Default Swaps (CDS) Guidelines

The guidelines for CDS that were last issued in January 2013 are to be reviewed. This is aimed

at aiding the development of a liquid market for corporate bonds, especially for the bonds of lower-rated issuers.

• Review of Comprehensive Guidelines on Derivatives

To promote efficient access to derivative markets while ensuring high standards of

governance and conduct in OTC derivative business by market makers.

• Comprehensive Review of Money Market Directions Being released for public feedback

4. External Trade-Facilitation 

• Direct Dispatch of Shipping Documents Remove the monetary ceiling to enable AD banks to regularise cases where export proceeds have been realized, irrespective of the export shipment value.
• Write off” of Unrealised Export Bills

Allowing write-off to the AD banks, without limits in specified circumstances, viz., cases

The overseas buyer has become insolvent, or the settlement of the export proceeds to be received has happened through the Indian Embassy, Foreign Chamber of Commerce or similar organizations or if the goods had been destroyed by the Port/Customs/Health authorities in the importing country.

• Set-off of Export Receivables against Import Payable

Permit AD banks to allow Indian companies to set-off their export receivables against import

payables in respect of goods and services with their overseas group/associate companies

either on a net basis or gross basis through a centralized treasury arrangement or otherwise.

• Refund of Export Proceeds: Allow AD banks to consider refund requests without insisting on import of goods, which are perishable in nature or had been auctioned/destroyed by the Port/ Customs/ Health authorities/ any other accredited agency in the importing country subject to production of documentary evidence

5.Payment and Settlement Systems

? Enabling Posting of Settlement Files of Payment Systems on all days of the week: Allow settlement files of payment systems (viz., AePS, IMPS, NETC, NFS, RuPay, UPI) to be

posted to the Reserve Bank on all days of the year.

? Card Transactions in Contactless Mode and e-Mandates on Cards for Recurring Transactions – Enhancement of Limit

: Enhance, at the discretion of the user, the limits for contactless card transactions and e- mandates for recurring transactions through cards (and UPI) from ?2,000 to ?5,000 from January 1, 2021.