The first soft signal of return to normalcy from Monetary Policy Committee?

There is no surprise in the outcome of the three-day meeting of the Monetary Policy Committee (MPC) that ended on Friday.

Based on “an assessment of the evolving domestic and global macroeconomic and financial conditions and the outlook”, the Indian central bank’s rate-setting body has kept the policy rates unchanged. The decision is unanimous. It is also in favour of continuing with the accommodative stance “as long as necessary” to “revive and sustain growth on a durable basis”. Just one of the six members of the MPC did not support this.

Still, the subtext of this policy is a bit different from the June policy. The Reserve Bank of India (RBI) sounds relatively more confident on growth now and, at the same time, its concerns on inflation are clearly higher. In fact, it has raised its inflation projection for the year, closer to the upper end of the band that the MPC is targeting.

This – along with the doubling of size of the 14-day variable rate reverse repo, or VRRR, auctions, from Rs 2 trillion to Rs 4 trillion in the second quarter of the financial year – may encourage some of us to interpret the latest policy as a soft signal to return to normalcy. This is why the 10-year bond yield rose 4 basis points to close at about 6.24 per cent (previous close was 6.207). A basis point is a hundredth of a percentage point.

RBI Governor Shaktikanta Das has, however, strongly emphasised that the increase in the size of the auction should not be read this way; it’s nothing but a tool for liquidity management.

The excess liquidity in the system is at its historic high now – around Rs 11 trillion. Among others, the combination of RBI’s secondary market G-sec acquisition programme (G-SAP) and redemptions of a bunch of short-term treasury bills in the second quarter will ensure that the liquidity sugar rush continues to flood the system. 

The VRRR, kept in abeyance during the pandemic, was re-introduced in January, and since then the Rs 2 trillion absorbed through this window is being rolled over every fortnight. The RBI has now decided to ramp up the size of the VRRR auction in phases to Rs 4 trillion by the second half of September. This is parallel to the fixed rate daily reverse repo window where banks earn 3.35 per cent for keeping excess money with the RBI.

Sounding more bullish on growth, the policy statement says the domestic economic activity has started normalising with the second wave of the pandemic ebbing; and although there is no rise in investment demand, better capacity utilisation, rising steel consumption and higher imports of capital goods, among others, should kick-start a “long-awaited revival”. It has kept its real GDP growth projection unchanged at 9.5 per cent for fiscal year 2022. For the first quarter of fiscal year 2023, the real GDP growth estimate is pegged at 17.2 per cent.

Like many other central bankers, the RBI Governor has maintained the stance that driven by supply shocks, inflation is transitory; but the inflation projection of the year has been raised substantially, from 5.1 per cent to 5.7 per cent “with risks broadly balanced”. Even for the first quarter of fiscal 2023, the RBI projection for inflation is 5.1 per cent, that too on a relatively high base. The MPC’s inflation target is 4 per cent with a 2 percentage-point band on either side.

Clearly, the MPC is aware that the threat of inflation is real. At the same time, the green shoots in Asia’s third largest economy seem to be showing. If both the trends continue, the RBI will be left with no choice but to start unwinding the super-accommodative stance of the monetary policy sooner than later. It is bound to start doing so by February 2023, if not in December 2022.

The policy statement says the MPC is conscious of its mandate of anchoring inflation expectations and will act as soon as the prospects for strong and sustainable growth are assured. For the time being, the RBI remains in “whatever it takes” mode, with a readiness to deploy all its policy levers – monetary, prudential or regulatory – to nurture the “nascent and hesitant recovery”.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd

His latest book: Pandemonium: The Great Indian Banking Story

To read his previous columns, please log on to www.bankerstrust.in

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