The monetary policy meetings seem to have reached a stage where decisions from the RBI will be more keenly watched than what the MPC delivers
The August policy minutes clearly reiterated the division of responsibility between the MPC and the RBI.
By Suvodeep Rakshit
The monetary policy meetings seem to have reached a stage where decisions from the RBI will be more keenly watched than what the MPC delivers. In the October meeting, the markets will be watching for RBI’s signals on addressing the liquidity glut along with normalization of reverse repo rates. The MPC will likely continue to stick with the accommodative stance, for now, while keeping the repo rate unchanged. All eyes for the next few meetings will be on the poteential liquidity normalization path and the reverse repo rate hikes but any sharp moves seem unlikely.
The August policy minutes clearly reiterated the division of responsibility between the MPC and the RBI. While the MPC decides on the stance and the repo rate, the rest of the monetary and liquidity tools, specifically the reverse repo rate, remains in the RBI’s purview. Some of the members highlighted that even with an accommodative stance the reverse repo rate and liquidity can be normalized—clearing the decks for the RBI to take over the normalization.
The MPC will go into the meeting with inflation in August surprising on the downside. The MPC estimated 2QFY22 inflation at 5.9% and 3QFY22 inflation at 5.3%. It is likely that the committee will need to revise their estimates lower. We estimate inflation at 5.3% and 4.6% in 2QFY22 and 3QFY22. However, lower near-term inflation prints do not imply that price pressures have subsided. Global commodity prices remain elevated with crude prices starting to threaten again. Global price pressures are visible in parts of the food basket too. Domestic manufacturers continue to gradually adjust prices higher which feed into core inflation. Further, as contact-based services open up with vaccinations gaining pace, some further price pressures will likely emerge in core inflation.
Economic activity has seen quick improvement but remains a mixed bag. By 3QFY22 the economy should be back to pre-Covid levels. The services sector is yet to recover fully, though a significant number of indicators are moving above the pre-pandemic levels. Activity levels will continue to improve and on a full year basis GDP growth should be around 9%. However, in terms of the size of the economy it is unlikely that India will get back to the non-Covid trend even in the medium term. The formal sector has seen healthy growth, evident from corporate earnings, however, the informal sector may not have seen similar strength. The K-shaped recovery, while helpful in sustaining near-term growth may not be supportive of long-term growth.
With a mixed bag in terms of both growth and inflation outlook, the RBI and MPC will want to wait for a clearer picture. But as the economy recovers, and given the financial stability perspective, it is also essential to gradually withdraw the excess liquidity and reverse an ultra-low interest rate regime with likely incipient asset price dislocations. Globally, central banks are at their inflection points and a few have turned the corner. Certainly, a lot of the excess liquidity has been involuntarily added due to foreign flows (chances are for further flows in the near term) though the RBI has adequate tools (MSS, OMO sales) to address them. The RBI needs to telegraph a path of normalization rather than let market expectations anchor unsuitably. The RBI has rightly focused on the near-term till now, and the October policy will be the perfect window to outline its thoughts on normalization, especially since the RBI will certainly want to avoid any sudden tightening.
(Suvodeep Rakshit is Senior Economist in Kotak Institutional Equities. Views expressed are the author’s own.)
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