Run-up to monetary policy review: Expected pause, surprise on stance?

A positive growth surprise from the gross domestic product (GDP) data and a downside inflation surprise from the recent consumer price index (CPI) prints provide a touch of ‘Goldilocks’ in the backdrop of the June Monetary Policy Committee (MPC) meeting. The predictability quotient is high for the June MPC as there is near unanimity among market participants that it is going to keep the policy rates unchanged. 

An encouraging softening in the core inflation momentum provides the space to observe the lagged effect of past rate hikes in nudging the headline CPI towards the medium-term target of 4 per cent, and also the risks of any unfavorable monsoon outcome. On the other hand, with the 4QFY23 GDP data coming out to be stronger than expected, there is no urgent need for a cyclical 

monetary policy support to growth. Most high-frequency growth indicators are also not ringing any alarm bells. Despite stronger headline growth, the composition of growth is favouring investment over consumption and hence, turns out to be less inflationary.

While there could be marginal tweaks to the RBI’s growth/ inflation forecasts and tone in the policy statement, the market focus could be on two tangible areas —  any change in monetary policy stance and any measures on liquidity management. Predicting the point at which the RBI will be comfortable changing the monetary policy stance has become difficult because of different interpretations of the stance even among MPC members. We think that three considerations could tilt the RBI towards holding on to the “withdrawal of accommodation” stance, but it will be a close call.

First, with some uncertainty from El Nino-related inflation risks still persisting and global central bankers not at the end of their rate-hike cycles, keeping the stance unchanged could be a prudent risk-management strategy towards keeping all options open. Second, headline CPI is still higher than the medium-term target of 4 per cent, even on a 12-month forecast horizon. If a change in stance is considered to be ‘too dovish’ by the markets, then the RBI’s efforts to achieve the target might be hampered. 

The policy stance has become an important communication tool and hence, the indirect impacts of that have to be assessed too. Third, both durable liquidity and banking system liquidity are now higher than where they were during the April policy. 

The increase in surplus liquidity could particularly be due to large foreign exchange interventions, higher RBI dividend to government and the Rs 2,000 note withdrawal process. A change in policy stance at this juncture might not be in sync with the current liquidity. 

Some MPC members might feel that with a sharper-than-expected moderation in headline/ core CPI, the real rates have reached a point where a change in stance to ‘neutral’ is warranted. 

A change in stance could be inferred by the markets as a definite sign of rates peaking. 

The MPC needs to be comfortable with expressing that softer than the ‘pause but not a pivot’ view of the April policy. It could be a surprise dovish signal for the markets, further supporting the current trend in falling yields.

The writer is Managing Director, Chief Economist, India Citi Research, Citigroup Global Markets India Private Limited