In a move that came a fortnight before schedule, the MPC delivered a 40bps repo rate cut, taking the repo rate to 4%. All six members voted for a rate cut, and five of the six voted for the 40bps cut (Dr Ghate voted for a 25bps cut). This is in line with our expectations. We were calling for a 40bps rate cut in this MPC round.

RBI cut the repo rate by 40bps. More steps by the central bank are likely to follow over the next few months, but now the focus could move more towards those who have not benefitted much from previous steps.

With this, RBI has eased the repo rate by a total of 115bps since mid-March. The effective easing is of a higher quantum in our view, of around 180bps (if the effective lending rate falls from the previous repo rate of 5.15% in mid-March, to the current reverse repo rate of 3.35%).

With this, RBI has eased the repo rate by a total of 115bps since mid-March. The effective easing is of a higher quantum in our view, of around 180bps (if the effective lending rate falls from the previous repo rate of 5.15% in mid-March, to the current reverse repo rate of 3.35%).

Beyond the rate cut, RBI announced several steps to improve the functioning of markets. The main steps were:

(1) a further three-month extension of the loan moratorium which was meant to expire in end-May

(2) additional space to spread out working capital interest payment (from September to March 2021),

(3) raising group exposure limits of banks to 30% from 25% earlier.

On inflation, while RBI acknowledged the “unusual spike” in food prices in April, it expects these to moderate as the lockdown eases. Normal monsoons, low oil and metal prices, weak demand and a favourable base are likely to pull headline inflation to below 4% in H2FY21. This is in line with our forecasts.

On growth, RBI said that even if the lockdown is lifted in end-May, activity will likely remain subdued for longer due to social distancing measures and labour shortage. It spoke about negative growth in H1, and improvement thereafter, without providing numbers. We expect growth at - ~7.5% in H1, before recovering in H2.

A “different” bouquet of measures could follow next
The muted response of the market (i.e. a 6bps rally) since the rate cut was announced suggests that the steps were broadly expected though the timing was not.

We believe more steps by RBI are likely to follow over the next few months, but now the focus could move more towards those who have not benefitted much from previous steps.

Sectors which remain stressed: The smaller NBFCs and corporates remain stressed, despite excess system-wide liquidity. The targeted LTRO (of Rs 500bn, announced on April 17) aimed at smaller NBFCs was not met with much success. RBI may consider sweetening the deal or perhaps taking on some credit risk itself. Sectors such as aviation are also disproportionately hit by the crisis. Steps such as providing long-term concessional funding may be needed.

Health of the banking system: The already high NPLs are likely to rise further through this crisis. If banks remain stressed, India's medium term potential growth is at risk. Some forward looking steps that can help, include :

(a)implementing a loan restructuring scheme for banks,

(b) revisiting the idea of a band bank, particularly for the real estate and power sector, and

(c) infusing liquidity in banks via bank recapitalization bonds.

Funding of the fiscal deficit: Despite an increase in government borrowing limits, bond yields have been fairly stable. The reason we believe is surplus liquidity, subdued private sector demand, and expectation of RBI action in the bond market. Over time, as the private sector begins to grow, and banks increase credit outflow, RBI may need to create the space by buying bonds, either in the secondary market (via OMO purchases) or in the primary market (direct monetisation of debt). RBI has been fairly proactive so far; experimenting with new measures may be needed next.

Bhandari is Chief India Economist & Chaudhary is Economist, HSBC Global Research. Views are personal.