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Razor’s edge dilemma may continue to weigh on RBI’s monetary policy review

On October 8, when the RBI meets for its bi-monthly monetary policy review, BFSI analysts expect the central bank to keep interest rates unchanged and maintain an accommodative stance. However, given the significant improvement in domestic economic activity and the upsurge in inflation worldwide, any indication of a gradual return to pre-pandemic monetary policy will be eagerly awaited. 

At the meeting of the Monetary Policy Committee held in August, Dr Ashima Goyal, a member of the committee, remarked that the MPC had a difficult task in dealing with both the slowdown and inflation induced by Covid. “The MPC remains in the same position as previously. Even though early indicators point to a revival, quantifying the trickle-down effect of growth to the bottom of the pyramid is difficult due to a lack of adequate data on the informal sector. On the other hand, the recent surge in global commodity prices demonstrates the upside risks to inflation,” Dr Goyal observed. 

Indranil Pan and Radhika Piplani, Business Economics Banking, YES Bank, point out that advanced economic indicators have undoubtedly improved in recent months. “As per the latest CMIE estimates, consumer sentiment has improved significantly in rural areas, possibly as a result of good kharif production, while it has slowed in urban areas. New investment announcements, as tracked by the CMIE, have continued to fall for the quarter ended September 2021, while credit growth remains muted. Even though economic activity appears to be holding up, the nature of the recovery may not be uniform across industries. We expect the MPC to maintain the current rates and stance. The RBI’s efforts to contain the overnight liquidity surplus from Rs 6.2 trillion will likely continue, with some adjustments to the quantum and duration of variable rate reverse repo (VRRR). We vote for the RBI to keep rates unchanged, including the reverse repo rate. We do not anticipate any shift in stance, while efforts to moderate liquidity will continue. An increase in the duration of the VRRR could be toyed with,” they said. 

Airing similar views, Shanti Ekambaram, Group President, Consumer Banking, Kotak Mahindra Bank, maintains that while the economic environment has changed since the last policy, the MPC is likely to keep a status quo on interest rates and an accommodative stance. “There is a greater uptick in economic activity, as seen by almost all high frequency indicators. Consumption demand is also rising, and this trend is expected to accelerate as the festival season approaches. These trends must sustain in order for the MPC to shift its stance on interest rates. While inflation has slowed since the previous policy, supply-side constraints and rising prices of fuel are likely to be inflationary. Global variables such as a crude price hike due to supply bottlenecks in China and the United Kingdom, as well as the Federal Reserve indicating that it is likely to begin tapering by the end of the year, might cause volatility. The MPC will closely monitor all these factors, with domestic growth and inflation likely to guide its policy stance. If the green shoots of economic recovery sustain, it is possible that some steps on liquidity and reverse repo will be taken in the latter part of the year,” Shanti added. 

According to Acuité Ratings & Research, the RBI will continue its accommodating monetary policy in October, while it is likely to take further steps to recalibrate the surplus liquidity in the monetary system over the next couple of quarters. Suman Chowdhury, Chief Analytical Officer of Acuité Ratings & Research, stated: “The recovery momentum remains uneven and not well-anchored across the economy. Systemically important central banks have thus far treated the rise in inflation as ‘transitory,’ while continuing to focus on supporting growth and recovery. However, central banks such as the Federal Reserve in the United States have increasingly taken a stance on moderating surplus system liquidity in a gradual manner through a tapering of their aggressive bond purchase programmes instead of initiating interest rate hikes. The RBI will also adopt a similar strategy over the next two quarters in order to optimise systemic liquidity before considering any rate hikes. With steady progress on vaccination and an increase in aggregate demand, Acuité anticipates that the RBI will begin normalising the policy corridor in December through a reverse repo rate hike. This is likely be followed by a rise in the benchmark repo rate in Q1FY23. Acuité continues to stick to its 10-year g-sec yield forecast of 6.5% by March 22.” 

Churchil Bhatt, Executive Vice President, Debt Investments, Kotak Mahindra Life Insurance Company, anticipates that the MPC’s October policy may indicate the end of excessive Covid-era accommodation amidst stable economic growth and progress in vaccination. “Even if deemed transitory, the unrelenting build-up of inflationary pressures is likely to elicit a measured central bank response – particularly on the surplus banking sector liquidity. Going forward, we anticipate that the Repo rate, which has ceased to be the operating rate since the pandemic, will reclaim its place as the key policy rate through a gradual and guided transition. However, the MPC may continue to emphasise its intention to maintain what would still be an otherwise accommodative monetary policy. Hence, we expect that an emphasis on a dovish, gradual tapering, coupled with the expected G-SAP 3.0 announcement, should keep any undue bond market volatility under check,” Bhatt said.

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