OPINION: RBI sticks to its stated trajectory but stands ready to act

The Reserve Bank of India (RBI) maintained status quo on policy rates as well as its accommodative stance in its fourth bi-monthly monetary policy decision that was announced on Friday – the decision was along expected lines.

The voting on the policy stance was not unanimous, with Prof. Jayanth Varma (a member of the monetary policy committee) voting against the formulation of the stance. This too was largely expected as he had voted against the stance in the August policy meeting also.

The minutes of the August meeting had revealed that he was not in favour of maintaining the reverse repo rate at 3.35% and had highlighted the need for the normalisation of the width of the liquidity adjustment facility (LAF) corridor as this would enable the monetary policy committee (MPC) to keep the repo rate at 4% for a longer period.

Importantly, the RBI continued on its stated path despite some recent disconcerting changes such as the coal crunch, the flare up in natural gas and crude oil prices and avoided any knee jerk reactions and yet gave enough hints that as the recovery is on a firmer footing, accommodation will be tapered in an orderly manner.

It revised its inflation projections downwards as inflation readings for July-August had surprised favourably with a larger-than-expected softening. It cut its full-year financial year (FY) 2022 projections to 5.3% from 5.7% earlier. It has revised downwards its Q2 [second quarter] and Q3 projections by 80bp each to 5.1% and 4.5%, respectively while maintaining its Q4 projection at 5.8%. It expects easing food prices and a favourable base effect to lead to a tempering in the near term. However, it has also expressed the need for supply-side measures to ameliorate core inflation, which continues to remain on the higher side.

The central bank highlighted that growth impulses were strengthening, and demand would likely be supported by the pick-up in progress of vaccination, pent-up demand particularly for contact intensive services, normal kharif sowing and bright prospects for the rabi crop. However, several downside risks for growth stem from the global semiconductor shortage, elevated commodity prices and input costs, potential global financial market volatility and uncertainty around the future COVID-19 trajectory. It has kept its growth projections for FY22 unchanged at 9.5% but has raised its Q2 and Q3 projections to 7.9% (vs. 7.3% earlier) and 6.8% (from 6.3% earlier). It has maintained its Q4 FY22 and Q1 FY23 projections at 6.1% and 17.2%, respectively. The double-digit projection for Q1 FY23 is quite surprising.

Importantly, the RBI also acknowledged that the liquidity conditions emanating from the exceptional measures instituted during the crisis would need to be scaled back in a gradual, calibrated, and non-disruptive manner. It decided to discontinue with the G-Sec Acquisition Programme (G-SAP) in H2 [second half of] FY22 while highlighting that there was a large liquidity overhang and no need for additional borrowing for (goods and services tax) GST compensation thereby limiting the need for further G-sec purchases. The central bank has injected a total liquidity of ₹2.37 lakh crore in H1 FY22 through open market operations (OMOs), including G-SAP -- as against an injection of ₹3.1 lakh crore over full-year FY21.

Overall, monetary policy continues to remain supportive of growth. While the RBI did discontinue with the G-SAP it stressed that it could bring it back if warranted and may likely undertake open market operations (OMOs) and Operation Twist also, if required. It mentioned the need to recalibrate liquidity gradually but did not disclose any timelines or a plan to undertake the same.

The RBI’s position was strengthened by the recent dip in inflation; however, the surge in global energy prices is disconcerting and is unlikely to abate in the near term. Besides, input cost pressures remain quite high (as is also reflected in the wholesale price index) and the passthrough to output prices remains limited owing to weak underlying demand. Thus, it would be premature to gain comfort on the inflation front and readings would be closely watched in the near term.

At the same time, the output slack is quite large, the recovery is uneven across sectors and the medium-term outlook for growth drivers remains hazy. The recovery in gross domestic product (GDP) numbers and underlying economic activity during [the] last three quarters (notwithstanding the hit to activity in Q1FY22 due to the [COVID-19] second wave) has largely been supported by demand spillovers; the recovery is likely to flatten once this pent-up demand is exhausted.

Given this backdrop, the RBI is likely to continue to focus on growth and maintain rates through the remaining part of FY22, but may begin a calibrated withdrawal of excess liquidity towards the end of calendar year (CY) 21.

Sachchidanand Shukla is a Group Chief Economist at M&M. Views are personal.

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