NEW DELHI: If one thing is clear from the August policy review, it is that the Reserve Bank of India (RBI) is now looking to move past its peak dovish stance. On Friday, the six-member Monetary Policy Committee (MPC) of the central bank voted unanimously to leave the policy repo rate unchanged at 4%. However, there is a divided view (with 5:1 majority) in keeping the stance accommodative amid unrelenting inflationary pressures. Yet, for now, the priority remains to support growth until data improves materially.
“The supply-side drivers (of inflation) could be transitory while demand-pull pressures remain inert, given the slack in the economy,” said RBI Governor Shaktikanta Das, adding that a pre-emptive monetary policy response at this stage may kill the “nascent and hesitant recovery” that is trying to secure a foothold in extremely difficult conditions. The governor pointed out that the high-frequency indicators suggest that consumption (both private and government), investment and external demand are all on the path of regaining traction even though the current levels of output remain below its pre-pandemic level.
Going forward, however, the RBI expects a broad-based recovery in demand to pick up with easing of restrictions. Primarily, a robust outlook for agriculture and rural demand will spurt private consumption. Early results from listed firms also show that corporates have been able to maintain their healthy growth in sales, wage growth and profitability, led by IT firms and this, the policy committee believes will also support aggregate disposable income of consumers. Economic recovery, Das said, would be supported also by buoyant exports, anticipated higher government expenditure and recent policy measures of the government. Investment demand may, however, not see an immediate improvement. Consumer confidence also remains weak for now. But, the July round results of the RBI’s consumer confidence survey suggest that the one year ahead sentiments returned to optimistic territory from historic lows.
Taking all these factors into consideration, the RBI has retained its projection for the current financial year at 9.5%, while the Q1 growth numbers have been revised upwards to 21.4% from 18.5% as of June forecast. The Q2-Q4 numbers, however, have been significantly downgraded. Real GDP growth for the first quarter of FY23 is projected to grow by 17.2% in the absence of a third wave of disruptions.
Meanwhile, of greater concern is the inflation projection that has been substantially revised upwards to 5.7% (from 5.1%) for FY22. It may be noted that headline inflation edged up sharply in May and June, breaching the 6% threshold, thanks to the high crude oil prices and subsequent rise in freight costs. Even then the RBI had said that “inflation is largely transitory”. Now, the central bank expects it to touch 5.9% in Q2, and moderate to 5.3% and 5.8% in Q3 and Q4, respectively. That’s not all. RBI said inflation will remain close to the upper band of the inflation target of 4% (+/- 2%) till Q1 of the next financial year.
“We believe inflation management could pose a serious challenge when the elevated fuel price pass through starts to occur and thus inflation shock is unlikely to be transitory even by definition,” according to Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India. Interestingly, the contribution of fuel, edible oil and pulses is currently more than 50% to rural headline inflation. Additionally, the second wave is having a significantly large fat tail and rural cases continue to be more than 40% in new cases, even as rural recovery continues to be patchy. “This will put further upward pressure on rural inflation,” Ghosh said, adding over the last one year, almost all inflation prints -- headline, core, rural and urban -- are converging close to 6% implying inflation may not be transitory.
Calibrated normalization on liquidity
Even as the latest policy meeting has tried to walk a tightrope in attempting to differentiate its liquidity manoeuvres from the accommodative policy rate stance, economists say that the current stance may not prevail for too long.
In fact, one dissent from MPC member Professor Jayanth Rama Varma and the re-introduction of the variable rate reverse repo (VRRR) auctions are largely seen as the beginning of its imminent exit from unconventional monetary easing. On Friday, the RBI doubled the quantum of VRRR to Rs. 4 lakh crore and it is set to conduct four VRRR auctions worth `13 lakh crore till September-end.
These auctions, Das repeatedly said, should not be interpreted as a reversal of the accommodative policy stance but economists and the markets disagree. “Recognising the excess build-up in systemic liquidity, we saw the RBI take its second step towards some form of liquidity normalisation. The first being the tolerance towards some upward adjustment in the 10-year yield in July,” noted Abheek Barua, chief economist, HDFC Bank. Daily systematic liquidity surplus has increased from Rs. 4-5 lakh crore in May to more than Rs. 8.5 lakh crore in August led by slowdown in currency in circulation.
Aurodeep Nandi, economist, Nomura, too, concurred.
“We believe that the liquidity manoeuvres suggest, at the very least, that the RBI is uncomfortable with the large amount of floating liquidity. As such, allowing bond yields to gradually rise and more VRRR issuance are a first step towards liquidity and policy normalization,” he said. For RBI, the next step, Nandi added, would be to wean off from the durable injectors of liquidity, followed by a narrowing of the policy corridor and finally hiking the policy repo rate. “In our baseline, we expect a 40bp hike in the reverse repo rate in Q4 2021 (Oct-Dec), followed by 75bp of repo and reverse repo rate hikes in 2022.”
Broadly, the policy was limited to granting extension in the timelines for some of the existing schemes.
This includes, extension of deadline of on-tap TLTRO for stressed sectors (including NBFCs) by three more months till December. Similarly, the three-month extension to the marginal standing facility limit will provide liquidity headroom to banks. RBI is also conducting open market purchase of government securities of Rs. 25,000 crore on August 12 under the G-sec Acquisition Programme (G-SAP 2.0). “Still, bond yield would remain at elevated levels. We expect the benchmark 10-year bond to rule around 6.2-6.3% for the next 1-2 months. It is not likely to move below 6.2% as the government borrowing programme and the GST compensation pressures continue to raise concerns,” said Madan Sabnavis, chief economist Care Ratings. Both benchmark equity indices and bonds fell after the policy announcement while the domestic currency strengthened against the dollar. Bond yields rose to 6.24% on Friday compared with 6.2% a day ago.