The Reserve Bank of India (RBI)- Monetary Policy Statement, 2020-21

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On the basis of an assessment of the current and evolving macroeconomic
situation, the Monetary Policy Committee (MPC) at its meeting today (May 22, 2020) decided to:
• reduce the policy repo rate under the liquidity adjustment facility (LAF) by 40 bps to 4.0 per cent from 4.40 per cent with immediate effect;
• accordingly, the marginal standing facility (MSF) rate and the Bank Rate stand reduced to 4.25 per cent from 4.65 per cent; and
• the reverse repo rate under the LAF stands reduced to 3.35 per cent from 3.75 per cent.
• The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target.
These decisions are in consonance with the objective of achieving the medium-term
target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 percent, while supporting growth.
The main considerations underlying the decision are set out in the statement below. Assessment

Global Economy:

2. Since the MPC met in March 2020, global economic activity has remained in standstill under COVID-19 related lockdowns and social distancing. Among the key advanced economies (AEs), economic activity contracted in the US, Euro area, Japan and the UK in Q1:2020. Among emerging market economies (EMEs), the Chinese economy went into a pronounced decline and data on high frequency indicators suggest that activity may have also shrunk in other EMEs such as Brazil and South Africa.

3. Global financial markets calmed after a turbulent period in March, and volatility ebbed as swift and large fiscal and monetary policy responses helped to soothe sentiment. Equity markets recovered some lost ground, while government bond yields remained range-bound, although somewhat elevated in some EMEs due to country specific factors. Portfolio flows to EMEs revived in April and the rush to safe havens
eased.

Domestic Economy:

4. Domestic economic activity has been impacted severely by the lockdown which has extended over the past two months. High frequency indicators point to a collapse in demand beginning March 2020 across both urban and rural segments. Electricity consumption has plunged, while both investment activity and private consumption suffered precipitous declines, as reflected in the collapse in capital goods production and the large retrenchment in the output of consumer durables and non-durables in March.

5. Retail inflation, measured by the consumer price index, moderated for the second consecutive month in March 2020 to 5.8 percent after peaking in January. This was mainly due to food inflation easing from double digits in December 2019 – January 2020. In April, however, supply disruptions took a toll and reversed the softening of food inflation, which surged to 8.6 percent from 7.8 percent in March. Prices of vegetables, cereals, milk, pulses and edible oils and sugar emerged as pressure points.

6. The Reserve Bank remained in pro-active liquidity management mode, expanding its array of measures, both conventional and unconventional, to augment system-level liquidity as also to channel liquidity to specific sectors facing funding constraints. Systemic liquidity remained in abundance, with average daily net absorptions under the liquidity adjustment facility (LAF) increasing to ₹5.66 lakh crore in May 2020 (up to May 20) from ₹4.75 lakh crore in April. During 2020-21 (up to May 20), ₹1,20,474 crore was injected through open market operation (OMO) purchases and ₹87,891 crore through three targeted long-term repo operation (TLTRO) auctions and one TLTRO 2.0 auction.

7. Reflecting the various liquidity management measures, domestic financial conditions have eased appreciably as reflected in the narrowing of liquidity premia in various market segments. Yields on government securities, commercial paper (CP), 91- day treasury bills, certificates of deposit (CDs) and corporate bonds have softened. The weighted average lending rates on fresh rupee loans of commercial banks declined by 43 bps in March 2020 alone.

8. In the external sector, India’s merchandise trade slumped in April 2020, with exports shrinking by 60.3 per cent and imports by 58.6 per cent (y-o-y), respectively. While imports contracted in all 30 commodity groups in April, exports contracted in 28 out of 30 groups. The trade deficit narrowed in April 2020 – both sequentially and on a yearon-year basis – to its lowest level in 47 months. On the financing side, net foreign direct investment inflows picked up in March 2020 to US$ 2.9 billion from US$ 0.8 billion a year ago. In 2020-21 so far (till May 18), net foreign portfolio investment (FPI) in equities increased to US$ 1.2 billion from US$ 0.8 billion a year ago.

9. The inflation outlook is highly uncertain. As supply lines get restored in the coming months with gradual relaxations in the lockdown, the unusual spike in food inflation in April is expected to moderate. The forecast of a normal monsoon also portends well for food inflation. Given the current global demand-supply balance, international crude oil prices are likely to remain low although they may firm up from the recent depressed levels.

10. Turning to the growth outlook, economic activity other than agriculture is likely to remain depressed in Q1:2020-21 in view of the extended lockdown. Even though the lockdown may be lifted by end-May with some restrictions, economic activity even in Q2 may remain subdued due to social distancing measures and the temporary shortage of labour. Recovery in economic activity is expected to begin in Q3 and gain momentum in Q4 as supply lines are gradually restored to normalcy and demand gradually revives. For the year as a whole, there is still heightened uncertainty about the duration of the pandemic and how long social distancing measures are likely to remain in place and consequently, downside risks to domestic growth remain significant. On the other hand, upside impulses could be unleashed if the pandemic is contained, and social distancing measures are phased out faster.

11. The MPC is of the view that the macroeconomic impact of the pandemic is turning out to be more severe than initially anticipated, and various sectors of the economy are experiencing acute stress. The impact of the shock has been compounded by the interaction of supply disruptions and demand compression. Beyond the destruction of economic and financial activity, livelihood and health are severely affected. Even as various measures initiated by the Government and the Reserve Bank work to mitigate the adverse impact of the pandemic on the economy, it is necessary to ease financial conditions further.

12. Accordingly, all members voted for a reduction in the policy repo rate and maintaining the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target.

13. Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Janak Raj, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted for a reduction in the policy repo rate by 40 bps, while Dr. Chetan Ghate voted for a reduction by 25 bps.

The minutes of the MPC’s meeting will be published by June 5, 2020