MPC. RBI focuses on sustaining economic revival

The Reserve Bank of India’s decision to keep the repo and reverse repo rates unchanged during its December monetary policy announcement was along expected lines. Amid fresh concerns over the Omicron variant of the coronavirus, the central bank rightly chose to prioritise supporting a still nascent and uneven revival of economic growth.

Interestingly, while the decision to keep policy rates unchanged in December was unanimous, retaining the accommodative monetary policy stance witnessed a 5:1 split voting, like in the October monetary policy committee (MPC) meeting.

The RBI rightly indicated that economic activities in India are on the mend but still need policy support, even as the central bank did not shy away from flagging its concerns over inflation. There was expectation from some quarters that the RBI would indicate a path to normalisation of monetary policy, along the lines of what has been seen in some other developed countries.

As the RBI chooses to refrain from doing so, one feels that it needs to be seen against the backdrop of relative deviation of India’s growth and inflation from their respective pre-pandemic trajectories.

Indeed, the central bank expects the headline CPI inflation to come in at 5.3 per cent in FY22 and further fall to 5 per cent in H1 of FY23. This is as against a targeted CPI inflation level of 4 per cent and upper tolerance band of 6 per cent.

Growth first

On the other hand, even if the GDP grows as per RBI’s estimate of 9.5 per cent in FY22, it will translate into GDP growth of a mere 1 per cent over two years, markedly lower than the usual 6-7 per cent in pre-pandemic years.

Against this backdrop, the need to prioritise growth over inflation can be appreciated better. This dynamic is quite different in the case of countries like the US, which possibly has prompted the US Fed to turn considerably more hawkish of late.

With the economy recovering from the Covid-led disruption, normalisation of monetary policy support will have four stages: (a) withdrawal of the large, crisis-time liquidity support; (b) narrowing the corridor between the repo and reverse repo rates by gradually hiking the latter; (c) shifting of the monetary policy stance to ‘neutral’ from ‘accommodative’; and (d) an eventual rise in the repo rate.

Like during earlier meetings, the RBI has made it clear this time as well that its decision to move from one stage to the next will follow a nuanced approach, keeping in mind the growth-inflation dynamic and while ensuring the stability of the financial system.

Withdrawal of emergency liquidity support already began since September with the progressively growing amount of liquidity sought to be mopped up through the Variable Rate Reverse Repo (VRRR) auctions and the lowering of the quantum of GSAP (Government Securities Acquisition Programme).

This was carried forward further with today’s proposal to enhance the 14-day VRRR auction amounts on a fortnightly basis to ₹6.5 lakh crore by mid-December, and further to ₹7.5 lakh crore by end-December. The absorption of liquidity surplus through VRRR auctions will have the effect of call rates in the money market inching upwards. This may eventually prepare the ground for a hike in the reverse repo rate — perhaps sometime in Q1FY23 — with minimal disruption.

As evident from the current policy guidance, the RBI will likely not rush to change to a ‘neutral’ stance till such time that the economic recovery turns more durable and sustainable.

Thus, MPC action in the coming months looks set to be calibrated and data-dependent, rather than a source of surprise for the economy and financial markets. The fourth and final stage is hiking the repo rate. The repo rate, the key policy rate for the MPC, currently at 4 per cent, is over 200 bps lower than its usual pre-Covid level.

The real repo rate — the difference between repo rate and inflation — stays deep into the negative zone since mid-2021.

However, the RBI may not contemplate hiking the repo rate before mid-2022 given persisting negative output gap and prolonged uncertainties, including the pace and durability of economic recovery, rising global prices of crude and other commodities, shortage of raw materials and supply bottlenecks.

Finally, among other policy initiatives, the proposed UPI-based payment products for feature phone users is an innovative one that should benefit a large chunk of India’s population, especially in rural and semi-urban areas. This should be another move towards championing greater financial inclusion over time.

The writer is the Chief Economist and Head of Research, Bandhan Bank. Views expressed are personal

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