Indian five hundred rupee currency notes. Image: iStock

MUMBAI – India’s central bank Wednesday held its key rates steady amid an uncertain outlook on inflation due to supply chain disruptions, risks to food prices, subdued demand for loans and the likelihood of a post-Covid crisis for large and small companies.

The Reserve Bank of India’s (RBI) decision came despite its prediction that the economy would contract in the first half of the year ending on September 30 as well as in the full year. Leading economists have forecast the economy could shrink from about 5% to possible low double digits.

“The real gross domestic product (GDP) growth in the first half of the year is estimated to remain in the contraction zone,’’ RBI governor Shaktikanta Das said.

“A more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks.’’

Borrowing by industry and services grew at a modest 5.6% as of mid-July, it said. This was despite borrowing costs plunging to their lowest levels in a decade because of strong liquidity in the banking system. The outlook remains hazy also because of pessimistic consumer confidence in July compared with earlier months.

Still, the transmission of low RBI policy rate cuts has been muted. Banks have been able to lower their weighted average lending rate only by 47 basis points from the 115 basis points cut in repo rate by the RBI since March this year, when India imposed the world’s biggest and among the most severe lockdown to contain the spread of the coronavirus.

Recognizing the fall in income because of a two-month countrywide lockdown and sporadic lockdowns at state levels, the RBI relaxed rules for borrowing against gold. India has one of the largest reserves of gold in personal holdings. Lenders can give loans of up to 90% of the value of the gold now compared with 75% of its value earlier.

The central bank didn‘t announce any projections for the shrinkage in GDP growth or acceleration in inflation by the end of the year.  Yields on government bonds maturing in 10 years were little changed at around 5.85%.  

“The outlook to growth continues to be negative with RBI refraining to give any number to the extent of GDP contraction on account of Covid-19,’’ Rajnish Kumar, chairman of the State Bank of India said.

“The asymmetric recovery across rural and urban areas poses a challenge in policy formulation. The outlook on inflation is equally uncertain as supply shock has limited the scope of monetary policy in containing risk.’’

Inflation as measured by the consumer price index accelerated to 6.1% as of June, compared with 5.8% in March, with price pressures evident in all sub-groups. The government’s decision to raise retail prices of petrol, diesel and cooking gas despite a fall in global crude oil prices is also expected to add to higher inflation.

The decision to hold the policy rate was prudent in the prevailing circumstances as the trajectory of economic growth, inflation and external demand remains uncertain, said SBI’s Kumar.

Holding rates steady also shows that the ability of monetary policy to stimulate growth is limited, said Anagha Deodhar, economist with ICICI Securities.

To help overcome economic uncertainty, the central bank said it will help large and medium sized companies to restructure their loans so that they don’t deteriorate to non-performing status.

In its July 24 Financial Stability Report, the RBI predicted the banks’ gross non-performing assets ratio could  rise to as high as 14.7% of all loans by March 2021 in the case of a “very severe” stress scenario, from 8.5% as of March 2020. For state-run banks the figure was 11.3% as of March and much less at 4.2% for private sector banks.

With the Purchasing Managers Index sliding for a fourth month along with exports and imports, bankers and economists are looking towards the government for more fiscal pump-priming to stoke growth.

“We think the economy will suffer its largest contraction on record this year,’’ Shilan Shah, senior India economist at Capital Economics wrote in a note.

“While the nature of the crisis means that the fiscal policy should be doing more of the heavy lifting, there is still a role for the RBI. But with the economic outlook this poor, we still expect a resumption in the monetary easing cycle.’’

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