Money policy guide: Inflation may be high, but RBI to stress growth priority

While CPI inflation is currently well above the Monetary Policy Committee’s medium-term target of 4 per cent, the rate-setting body is expected to look past price pressures and attribute them mostly to supply-side factors.

The MPC is expected to hold the repo rate steady at 4 per cent and the reverse repo rate at 3.35 per cent at the conclusion of its three-day meeting. The MPC’s statement will be part of the RBI Governor Shaktikanta Das’ address at 10:00 am on Friday. The central bank will upload the MPC statement, Governor’s speech and the statement on development and regulatory policies on its website post the policy announcement.

“The MPC meets on the cusp of a visibly sticky inflation, the compulsion to nudge growth and a fluid pandemic situation the world over. The central bank is most likely to maintain status quo on rates being mindful of growth and wait for more data points on the inflation front,” said Lakshmi Iyer, chief investment officer for debt at Kotak Mutual Fund.

MPC STATEMENT

Expect the statement by the members of the rate-setting panel to acknowledge the recent recovery in various high-frequency indicators since June after a decline in April and May due to the second wave of Covid-19 infections.

However, the panel’s principal focus is likely to be on ensuring a sustainable recovery in growth, rather than highlighting indicators that have been exaggerated by the statistical effect of a low base after last year’s GDP contraction of 7.3 per cent.

The statement is likely to reassert its stance of accommodative monetary policy “as long as necessary to revive and sustain growth on a durable basis,” said one policy watcher.

Recent comments by Governor Shaktikanta Das provide hints on Mint Street’s thinking. Das said last month that any hasty withdrawal of the current loose monetary policy could inflict more pain than gain on the struggling economy.

PRESS CONFERENCE

The RBI Governor and deputy governors will address the media at 12:00 pm on Friday, where the Governor is likely to point to the fragile nature of the economic recovery to support the MPC’s emphasis on growth by maintaining an accommodative policy stance.

Focus will also be on the central bank’s government bond yield management after recent activity suggested that RBI is willing to let yields on the 10-year benchmark government bond adjust higher after keeping it capped at around 6 per cent for the better part of 2021.

Since the pandemic struck, a large part of RBI’s policy focus has been on the sovereign bond market, which is the pricing reference for the bulk of credit products in India. The central bank has since April announced more than Rs 2 lakh crore of government bond purchases under a new plan referred to as the ‘Government Securities Acquisition Programme’.

What Morgan Stanley is watching …

First, if there are any changes to inflation forecasts. RBI current inflation forecast is at 5.1 per cent, while consensus has moved higher to 5.5 per cent and risk assessment around the inflation forecast as core inflation remains sticky. Secondly, the confidence of RBI in growth recovery and its assessment of risks arising from Covid-19 and the pace of vaccination; And thirdly, any early indications on RBI’s comfort to nudge short-term rates higher probably through longer-term reverse repos. This could set the stage for a slow-paced normalisation of the accommodative stance.

LIQUIDITY NORMALISATION

Core liquidity, which is the sum of banking system liquidity and government’s cash balance, has swollen past Rs 10 lakh crore because of a combination of various factors such as RBI taking delivery of forward dollars, which entails accretion of rupee liquidity in the banking system, Treasury bills worth almost Rs 2 lakh crore maturing in September quarter and RBI purchasing government bonds in order to keep sovereign borrowing costs low.

With the central bank committed to keeping financial conditions easy to allow growth to recover fully, especially given the possibility of a third Covid-19 wave, talk of any liquidity normalisation is unlikely. Iyer of Kotak MF, however, expects some guidance on the same through increase in tenor or quantum of the variable rate reverse repo auctions “something which bond markets seem to be anticipating.”

While announcements of liquidity management operations don’t fall under the purview of the MPC, RBI has used the policy platform to communicate its liquidity policy with the market over the past year and a half.

The growth-inflation mix requires deft management, especially in the midst of a black swan event such as the Covid crisis. All eyes are on RBI’s next step now.