RBI holds rate, ups inflation projection

RBI will “continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy,” the MPC resolution said.

The Reserve Bank of India’s Monetary Policy Committee (MPC) reiterated its commitment to reviving sustainable economic growth even as it raised the inflation projection for the current fiscal year to 5.7%, an increase of 60 basis points – one basis point is one hundredth of a percentage point – compared to the projection in its June meeting.

The MPC resolution also put the onus of bringing down petrol-diesel prices on the Union and state governments through tax reduction. (Mint)

There is no doubt about what RBI thinks is more important at this point in time; RBI governor Shaktikanta Das (he quoted Martin Luther King Jr in his comments) termed inflationary pressures “transitory”, and “driven by adverse supply side factors” and was unequivocal that “at this stage... continued policy support from all aides -- fiscal, monetary, and sectoral -- is required to nurture the nascent and hesitant recovery”.

And the policy rate (at 4%) and monetary policy stance have been kept unchanged at 4% and accommodative.

The message is clear: RBI thinks growth is a concern, not inflation. It is not an assessment with which all analysts agree, not least because inflation has been stubborn.

The MPC resolution also put the onus of bringing down petrol-diesel prices on the Union and state governments through tax reduction. While it has retained its 2021-22 gross domestic product (GDP) growth forecast of 9.5%, it has underlined demand side headwinds to the ongoing economic recovery. Experts have highlighted two facts -- a difference of views within MPC on the question of retaining the accommodative policy stance and the central bank announcing additional variable rate reverse repo auctions (which will take back some of the excess liquidity in the system) -- to argue that the monetary policy will see a gradual normalisation of policy setting and perhaps move in sync with the country’s vaccination programme.

RBI will “continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy”, the MPC resolution after its three-day meeting from August 4-6 said. The focus on prioritising the ongoing economic recovery despite high inflation was justified on the grounds of achieving a gradual reduction in inflation. “The approach to inflation is not a cold turkey method, where you slam the economy until it goes limp,” RBI deputy governor Michael Patra said. “It is important to bring that down over time and not immediately.”

Patra’s remarks are in line with the MPC’s inflation prognosis. “The current assessment is that the inflationary pressures during Q1:2021-22 are largely driven by adverse supply shocks which are expected to be transitory,” the MPC resolution said.

The emphasis on protecting the economy makes sense when read with the MPC’s assessment of the economy. “The outlook for aggregate demand is improving, but still weak and overcast by the pandemic. There is a large amount of slack in the economy, with output below its pre-pandemic level,” the resolution said. While the MPC has increased its forecast for GDP growth in the June 2021 quarter from 18.5% to 21.4%, growth forecasts for the next three quarters of the current fiscal year have seen a downward revision this time. This suggests a weakness in demand going forward.

The MPC’s projections are in line with the trend seen in high frequency indicators in the month of July.

While Purchasing Mangers’ Index (PMI) for manufacturing showed an impressive jump to 55.3 from 48.1 in June, PMI services remained below the critical threshold of 50, values above which signify an expansion in economic activity, compared to last month. The Nomura India Business Resumption Index has also shown a marginal fall in the last two weeks; from 96.4 in the week ending July 18 to 95 in the week ending August 1.

“We think there are some good reasons why RBI should begin to plan a gradual exit (from loose monetary policy). Inflation has been higher than 4% for 21 months and is likely to remain so over the foreseeable future. And monetary policy has its limits in driving growth. It is a countercyclical tool and can help close the output gap, but not drive potential growth,” Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets, said in a note.

“Deputy governor’s comments on growth and inflation indicate that RBI would be patient in withdrawing accommodation. Next steps in the gradual normalisation in October could be further increase in the VRR volume and reduction in 3Q GSAP but a reverse repo hike could be delayed,” Samiran Chakraborty, chief India economist at Citi Research, said in a note.

Aurodeep Nandi, India economist and vice president at Nomura, said: “From a head-in-sand approach on higher inflation so far, this policy meeting finally saw some implicit acknowledgement that continued disregard for inflation ultimately comes at the cost of policy credibility and markets eventually exacting higher risk premia. This was reflected in the dissent of one of the MPC members against the accommodative stance, and the RBI’s move to slowly start draining the liquidity swamp.”

However, Nandi added, “The policy has tried to tread a tightrope in attempting to differentiate its liquidity manoeuvres from the accommodative policy rate stance, and continuing to insist that inflationary pressures remain temporary and that the growth recovery is still in its nascence.”

Uday Shankar, president, Federation of Indian Chambers of Commerce and Industry (Ficci), said: “The Central Bank’s indication yet again to continue with the accommodative stance, until necessary, to revive growth is encouraging. This is especially comforting when there was an expectation about the normalisation of the monetary policy. The central bank has thoughtfully navigated the monetary policy through the pandemic. We are confident that the same thoughtfulness will continue in the future especially in view of an anticipated third wave and the continuing softness in the economy.”

Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, said in the SBI Ecowrap: “While the policy strikes a delicate balance between reinvigorating growth and keeping inflation in check, it seems that RBI growth projections being retained at 9.5% is more of a statistical artefact as Q1 growth numbers have been revised upwards, while Q2-Q4 growth numbers have been significantly downgraded. Thus it is clear that the central bank currently foresees recovery as incipient which will likely lose steam as pandemic uncertainties continue to rule the roost. This provides a clear justification for central bank to continue supporting growth till it revives.”