Growth momentum regains, inflation worries resurface

RBI is likely to hold rates, maintain an accommodative stance

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is likely to hold interest rates when it meets to review the policy on August 4-6 while maintaining the accommodative stance.

Growth concerns have ebbed substantially since the last review in June while retail inflation remained elevated.

If the central bank maintains a status quo on Friday, it will be for the seventh consecutive monetary policy review meeting to keep rates on hold.

The repo rate was last reduced in May 2020. After the imposition of nationwide lockdown in March 2020, the central bank promptly responded with a sharp 75 basis points cut in the repo rate and another 40 bps rate cut in May. The repo rate is currently at 4%.

“We believe that the RBI will continue to keep rates on hold. And retain its accommodative stance in the upcoming policy review as growth concerns dominate even as discussions around inflation are expected to gain prominence,” Morgan Stanley said in a note to its clients.

After the GDP contracted 7.3% in the last financial year, the RBI has estimated GDP growth at 9.5% for the current financial year.

The second wave of the Covid-19 pandemic due to which economic activity came to a standstill as several states had imposed lockdowns in April and May, prompted the central bank to revise its growth target to 9.5% in June, from 10.5% projected in April.

“While virus caseload has declined significantly since April, the overall trajectory of economic variables has not changed sufficiently to warrant any material change in the RBI’s policy stance in the August MPC meeting”, said Rahul Bajoria, Chief India Economist, Barclays.

“ We expect the RBI to keep rates unchanged in August”, Bajoria added.

Retail inflation, measured by the Consumer Price Index (CPI), rose 6.26% in June from a year ago. It is above the central bank’s comfort zone. The MPC’s mandate is to maintain inflation at 4%, within a range of +/- 2%.

“While the economic picture looks similar to the April MPC meeting, growth risks are no longer to the downside. Still, the RBI may not be in a position to provide clarity on its normalisation path, except to signal a willingness to use policy tools to retain its inflation-fighting credibility,” Bajoria said.

Sticky inflation may prompt the central bank to revise its inflation forecast upwards from 5.1% projected in the June policy.

Economists expect the central bank to maintain its June growth forecast.

“Expect the MPC to dial up its FY22 inflation forecast from the present 5.1% y/y. Headline CPI inflation has stayed above the 4% target midpoint for 21 consecutive months and above the 6% tolerance band for more than half of that period,” said Radhika Rao, Economist, DBS Group Research.

The one message which the market participants look forward to from the MPC’s policy statement is whether there is any indication on when the central bank will start unwinding the ultra-easy monetary policy.

Since the pandemic broke out, the central bank’s priority was to revive growth on a durable basis, as ample liquidity was maintained in the banking system to keep interest rates benign.

“We expect the RBI to follow a relatively quick normalisation cycle, but the time to signal this change, of course, is in the future, not the present.”, Bajora said. “ As such, we see no tangible benefit for the RBI to provide clarity on its normalisation path right now.”

In our view, once the RBI is confident in the sustainability of a growth revival, the bank will start to hike interest rates and unwind the extraordinary support provided during the pandemic reasonably quickly,” Bajoria said.

The central bank also opened a separate liquidity tap in April, namely the Government Securities Acquisition Programme (G-SAP), on the lines of quantitative easing (QE) of global central banks.

In recent media interactions, RBI governor Shaktikanta Das ruled out any possibility of policy normalisation soon.

“The market is keenly watching for guidance on liquidity withdrawal,” Rao said. “Forward guidance will favour a continuation of the accommodative policy stance to guard against growth risks, especially the third Covid wave.’

“The accompanying commentary will heed inflation risks through close monitoring and refrain from tweaking the policy levers for now,” she added.

Interestingly, the yield on the 10-year benchmark government bond moved up 11 basis points since it was introduced on July 9. The new 10-year bond was introduced at 6.10%, which was at a higher rate than the prevailing yield. The bond dealers said movement of the yield is an indication that the central bank is allowing the market to adjust with the fundamentals - particularly inflation, which is on the higher side.

This is seen as a departure from its recent stance when RBI was not allowing yields to harden while emphasizing the orderly evolution of the yield curve.

Even if the central bank defers talks about normalisation of policy on August 6 but having a higher tolerance level of bond yields may be an indication that the unwinding of the ultra-lose policy could happen sooner than later if the country can avoid a devastating third wave.

(The writer is a Mumbai-based journalist)