Eye on inflation, RBI likely to keep policy rates unchanged

MUMBAI: The Reserve bank of India (RBI) is expected to keep key policy rates unchanged when it next meets on 2-4 December to review monetary policy, as per a survey of ten economists. According to the survey findings, while economic recovery will continue to remain the cornerstone of the central bank’s monetary policy focus for the foreseeable future, high inflation, that has hovered at the 6% mark, will likely outweigh other concerns in the next policy review.
India’s retail inflation based on Consumer Price Index (CPI) hit a nearly six-and-a-half-year high of 7.6% in October, with food inflation registering a steep rise.
All the 10 respondents polled expect RBI to maintain repo rate at 4% while maintaining an accommodative policy stance for future interventions. “While the risks to growth still persist, RBI has had to adopt a judicious mix of maintaining an accommodative stance alongside holding rates steady in recent months as headline and core inflation indices have remained stubbornly elevated,” said Shubhada Rao, founder QuantEco Research.
Majority of respondents, however, expect the central bank to remain in wait-and-watch mode for the rest of the fiscal, contrary to their earlier projection of a rate cut before year end.
“We now expect the RBI to stay on hold through 2021 (vs our previous forecast of a 50bp cut), as inflation has remained stubbornly high, closing the window for policy easing. At next week’s policy meeting, we expect the RBI to revise up both its growth and inflation projections, but retain the dovish forward guidance,” said Nomura in a note.
Majority of economists expect RBI to revise both growth and inflation forecasts for this year. The latest gross domestic product (GDP) number showed that Indian economy saw a sharp recovery in the second quarter from the record decline of 24% during April-June. GDP contracted 7.5% in the July-September quarter, lower than the 8.6% decline predicted by the central bank’s “nowcast” model. Economists, however, are cautious about risks of a slowdown as they see resurgence in infections after the festive season. In its previous policy, RBI had estimated real GDP growth in financial year 2021 to be (-)9.5%, with risks to the downside.
Inflation on the other hand has been a nagging concern. RBI had earlier projected consumer price inflation (CPI) at 6.8% for the second quarter and 5.4-4.5% for the second half of fiscal 2021. This is likely to see an upward revision, according to economists.
“Inflation has also surprised on the upside, remaining above the upper tolerance level of 6%, mainly due to supply-side factors, such as unseasonal rains (vegetables), the cobweb cycle (pulses), labour shortages, higher services prices (as firms look to mend their balance sheets), higher commodity prices (oil, gold) and higher taxes. In light of this upside surprise, we expect the RBI to revise up its inflation projection by more than 1 percentage points (pp) to 5.5-6.9% in H2 FY21 (from 4.5-5.4%) and a new H1 FY22 forecast of 4.2-4.8%,” Nomura said in its note.
RBI has, however, sought to infuse liquidity without tinkering with benchmark rates. In October, the RBI allowed on-tap targeted long-term repo operations (TLTRO) for banks to borrow up to ₹1 trillion from the window and invest in corporate bonds and other debt instruments of certain sectors. It also announced that the size of open market operations, under which the RBI buys and sells government securities, will be raised to ₹20,000 crore to flatten the yield curve and keep interest rates benign. These measures had resulted in a surge in system liquidity and subsequent decline in interest rates across the economy.
Funds are easily available at competitive rates. Yet investment confidence is low due to the uncertainty about the duration of pandemic and the ongoing economic slowdown. I now expect RBI to come out with measures to absorb excess liquidity to reduce irrational pricing of money market instruments and protect the interest of savers,” said Rupa Niture, chief economist, L&T Finance.
“With so much liquidity floating around, and bank credit still on the slow growth trajectory, as a matter of policy, RBI should be directing liquidity flow towards the long-end given the excessive fall in short-end yields. One way of achieving this is by advancing the CRR cut which is expiring on March 27, which would lead to the draining of ₹1.46 lakh crore from the market. To balance that, RBI should announce simultaneous open market operations of an equivalent amount. Another possibility could be allowing mutual funds to participate in reverse repo in conjunction with a Standing Deposit Facility so that a floor is established. RBI can also introduce a Market Stabilization Scheme as was done earlier in times of excess liquidity conditions during demonetisation,” said Soumyakanti Ghosh, chief economist, State Bank of India. —Agencies


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