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A defining moment for RBI monetary policy

Mini

The monetary policy committee (MPC) will almost certainly hold the repo rate unchanged in the current meeting. Nevertheless, there are a number of areas of interest to watch out for.

A defining moment for RBI monetary policy
The monetary policy committee (MPC) will almost certainly hold the repo rate unchanged in the current meeting. Nevertheless, there are a number of areas of interest to watch out for. These include the roadmap for absorbing the prevailing large systemic liquidity surplus; the quantum of government securities acquisition programme (GSAP) in the coming months, possible announcements related to variable rate reverse repos (VRRR), and finally whether the central bank will decide to reduce the width of the policy rate corridor from the current 65 basis points (bps) by raising the reverse repo rate.
Fresh global uncertainties
Monetary policy is facing fresh challenges of late across the globe. On the one hand, sharp, unexpected headwinds like major disruptions in supply of industrial raw materials, fuel and energy in a number of leading economies in recent months has emerged as a key risk to the pace of near term economic recovery. On the other hand, commodity price inflation led by Covid-induced supply disruptions – which was believed to be ‘transient’ for several months – seems to be spilling over to a wider set of goods and services.
Such developments on the growth-inflation front mean additional uncertainty as regards the start-date, nature and pace of reversal of central banks’ excessive policy accommodation, which is widely believed to be round the corner. Volatility in financial markets have inched higher, with the volatility index (VIX) averaging nearly 20 in September, as against about 17.5 in August. Bond yields have also moved higher by 15-30 bps across a number of advanced economies during September.
Growth inflation projections
In India, the macro backdrop is a mixed bag. Improvement in the Covid scenario since June has been quicker than expected, leading to sharp easing in mobility and logistics-related bottlenecks. The GDP print (~20 percent growth year-on-year) for the quarter ending June had broadly been on expected lines, benefiting heavily from an abysmally low base.
High-frequency indicators suggest that economic activity continues to improve during the following quarter as well, but not in tandem with the strength of the upside surprise as regards the Covid scenario. Also, recovery in business and consumer confidence will likely be a gradual process only. As per the RBI’s own survey, urban consumer confidence virtually did not improve since the multi-year lows of 2020. Overall, while uptick in recent high frequency indicators may provide greater comfort, we expect the MPC to maintain their 2021-22 growth forecast of 9.5 percent in the current meeting.
On the inflation front, CPI prints during July and August – that averaged below 5.5 percent, nearly 1 percentage point lower than during May and June – clearly offered a bit of immediate breathing space for the MPC. The RBI’s existing inflation projection of 5.9 percent for the quarter ending September looks set to be undershot. However, a large number of fresh uncertainties, which include rising commodity prices (eg., energy, food, metals), elevated energy prices at home, and patches of unseasonal rains closer to the harvest season for the summer crop, are bound to raise concerns for the MPC. Overall, despite the relief from the most recent prints, the MPC will possibly retain its CPI forecast of 5.7 percent for 2021-22 in the October meeting, even if they acknowledge a number of risks on both sides.
A nuanced approach
Overall, the growth inflation backdrop is clearly more complicated for the MPC in the current meeting than in recent months. Risks on the inflation front are large, multi-dimensional, and largely beyond the direct influence of monetary policy in the near term. Policy choices in the coming months will possibly serve as defining moments and important precedence for monetary policy. Importantly, one of the MPC members has already voted against the accommodative stance.
Nevertheless, the decision to withdraw crisis-time policy support has to be nuanced and gradual, even if erring on the side of caution, rather than a source of surprise in the current nascent and uneven nature of recovery. The MPC has rightly shown a dovish bias in the recent past and has indicated repeatedly that they will remain data-dependent. Importantly, while a likely near-double digit growth in 2021-22 would mean a strong uptick optically, India’s GDP is virtually in the middle of a phase of zero growth over a two-year period. Also, it is felt – as suggests a recent IMF report – that the Covid pandemic might cause a larger dent in India’s long-term growth prospects than most peers.
Finally, RBI’s rate cuts in 2020 had been more nuanced compared with several peers, thereby, cushioning the MPC from embracing the hiking cycle in a hurry.
Against that backdrop, guidance, if any, from the RBI as regards absorbing part of the crisis-time liquidity support will be important.
Lowering the quantum of GSAP and/or further VRRR auctions are possibilities. Also, an early step towards policy normalization might be normalization of the policy rate corridor from the current, wider-than-usual 65 bps. This may in fact be triggered in one of the MPC meetings fairly soon. However, with the help of continuous and effective communication from the central bank during and outside the MPC meetings, market participants have prepared for this to an extent; with a relatively limited surprise element, such moves should not cause any material disruption.
—Siddhartha Sanyal is Chief Economist & Head of Research in Bandhan Bank. The views expressed are personal
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