Aug'21 -RBI Policy Highlights

Writer #IndiaBonds | Aug 9, 2021 5 min read

The RBI’s Monetary Policy Committee (MPC) conducted its 3rd bi-monthly monetary policy meeting for FY21-22 from 4-6, August 2021.

On the basis of an assessment of the evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today decided to:

Keep the policy repo rate unchanged at 4.0%.
Accordingly, the marginal standing facility (MSF) rate and the Bank Rate stand unchanged at 4.25%.
The reverse repo rate under the LAF stands unchanged at 3.35%.
GDP growth for FY22 retained at 9.5%.
Inflation projections for FY22 increased from 5.1% to 5.7%.
Accommodative stance to continue; policy geared towards rejuvenating growth.

Part A: RBI’ s Policy decision Rationale:

1. Inflation
Headline inflation surprised on the upside in May’21 at 6.30%, reflecting a combination of adverse supply shocks, elevated logistics costs, high global commodity prices and domestic fuel taxes. In Jun’21, headline inflation remained above the upper tolerance level at 6.26%, but price momentum moderated. Also, core inflation softened from its peak in May’21 of 6.6%. International crude oil prices remained volatile; any moderation in prices as a consequence of the OPEC plus agreement could contribute towards alleviating inflation pressures.

The MPC expects CPI outlook to be subjected to both upside and downside pressures such as:

Recent inflation spikes are expected to be transitionary in nature.
Any moderation of price as a consequence of OPEC+ agreement could contribute towards alleviating price pressures.
Arrival of monsoon after a brief hiatus and gain of momentum in kharif sowing to help cool food inflation.
Rising Covid-19 cases in parts of the country may lead to supply side bottlenecks.

Based on the above factors, the MPC has provided the following outlook for CPI Inflation, with risks broadly balanced:

CPI Inflation Outlook	Projections
CPI Inflation Outlook	Q2FY22	Q3FY22	Q4FY22	Q1FY23	FY22
3^rd bi-monthly policy FY22	5.90%	5.30%	5.80%	5.10%	5.70%
2^nd bi-monthly policy FY22	5.40%	4.70%	5.30%	-	5.10%

2. Growth

The MPC expects growth outlook to be driven by the following factors:

Easing of restrictions amid increasing coverage of vaccinations.
Rural demand and agriculture to continue to remain strong.
Urban demand likely to accelerate with recovery in manufacturing and non-contact intensive services, release of pent-up demand and the pace of vaccination.
External demand remained buoyant during Q1FY22 and was reflected in increasing exports, lending critical support to aggregate demand.
Global commodity prices and episodes of financial market volatility, together with vulnerability to new waves of infections are, however, downside risks to economic activity.

Based on the above factors, the MPC has provided the following outlook for Real GDP growth:

GDP Growth Outlook	Projections
GDP Growth Outlook	Q1FY22	Q2FY22	Q3FY22	Q4FY22	Q1FY23	FY22
3^rd bi-monthly policy FY22	21.40%	7.30%	6.30%	6.10%	17.20%	9.50%
2^nd bi-monthly policy FY22	18.50%	7.90%	7.20%	6.60%	-	9.50%

3. Liquidity

Ample liquidity due to Reserve Bank’s purchase of government securities in the secondary market and capital flows, total absorption through reverse repos surged from a daily average of Rs 5.7 lakh crore in Jun’21 to Rs 6.8 lakh crore in Jul’21 and further to Rs 8.5 lakh crore in Aug’21 so far.
Reserve Bank will purchase securities under G-SAP worth Rs 25,000 cr each on 12th Aug’21 and 26th Aug’21.
The reduction in repo rate by 250 basis points since Feb’19 has resulted in a cumulative decline by 217 basis points in the weighted average lending rate (WALR) on fresh rupee loans.

4. Global Economy

Global economic recovery which had gained growth momentum has started to moderate due to resurgence in pandemic, driven by new variants. Most advanced economies with high vaccination density and policy stimulus showed strong growth rebound, whereas other economies remained subdued in terms of growth due to ongoing risk of new infections. Recent OPEC+ decision to increase supply will provide some relief to inflation concerns. Yields in most advance economies softened. Emerging market economies, on the other hand, remained elevated on country-specific factors. In the foreign exchange market, EME currencies depreciated in the wake of portfolio outflows since mid-June as risk appetite ebbed, while the US dollar has strengthened.

Part B: Key Statements on Developmental and Regulatory Policies:

1. On Tap TLTRO Scheme – Extension of Deadline
RBI has extended the TLTRO on Tap Scheme, which was previously available up to Sep 30, 2021, by a period of three months, i.e., till Dec 31, 2021.

2. Marginal Standing Facility (MSF) - Extension of Relaxation
RBI has extended the MSF relaxation, which was previously available up to Sep 30, 2021, by a period of three months, i.e., till Dec 31, 2021.

The next meeting of the MPC is scheduled during Oct 06 - Oct 08, 2021.

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Frequently asked questions

A bond's yield refers to the expected earnings generated and realized on a fixed-income investment over a particular period of time, expressed as a percentage or interest rate. The simplest way to calculate a bond yield is to divide its coupon payment by the face value of the bond. This is called the coupon rate or coupon yield.

Coupon Rate = Annual Interest Payment / Bond Face Value

However, if the annual coupon payment is divided by the bond's current market price, the investor can calculate the current yield of the bond. Current yield is simply the current return an investor would expect if he/she held that investment for one year, and this yield is calculated by dividing the annual income of the investment by the investment’s current market price.

Coupon Rate = Annual Interest Payment / Bond Market Price.

Yield to maturity (YTM) is the overall interest rate earned by an investor who buys a bond at the market price and holds it until maturity. Mathematically, it is the discount rate at which the sum of all future cash flows (from coupons and principal repayment) equals the price of the bond. YTM is often quoted in terms of an annual rate and may differ from the bond’s coupon rate. It assumes that coupon and principal payments are made on time. Further, it does not consider taxes paid by the investor or brokerage costs associated with the purchase.
The formula for calculating YTM is shown below:

In addition to evaluating the expected cash flows from individual bonds, yields are used for more sophisticated analysis. Investors may buy and sell bonds of different maturities to take advantage of the yield curve, which plots the interest rates of bonds having equal credit quality but differing maturity dates.
The slope of the yield curve gives an idea of future interest rate changes and economic activity. Investors may also look for difference in interest rates between different categories of bonds.

A yield spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, issuer, or risk level, calculated by deducting the yield of one instrument from the other -- for example the spread between 5-year AAA corporate bonds and 5-year Gsec. This difference is most often expressed in basis points (bps) or percentage points.

A bond's face, or par value will often differ from its market value. This has to do with several factors including changes to interest rates, a company's credit rating, time to maturity, whether there are any call provisions or other embedded options, and if the bond is secured or unsecured. A bond will always mature at its face value when the principal originally loaned is returned.

Bond prices and yields act like a seesaw: When bond yields go up, prices go down, and when bond yields go down, prices go up. A bond that pays a fixed coupon will see its price vary inversely with interest rates. This is because bond prices are intrinsically linked to the interest rate environment in which they trade for example - receiving a fixed interest rate, of say 8% is not very attractive if prevailing interest rates are 9% and become even less desirable if rates move up to 10%. In order for that bond paying 8% to become equivalent to a new bond paying 9%, it must trade at a discounted price. Likewise, if interest rates drop to 7% or 6%, that 8% coupon becomes quite attractive and so that bond will trade at a premium to newly issued bonds that offer a lower coupon.

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