Rate standstill fails to hide emerging taper debate on Mint Road

Reserve Bank of India (RBI) Governor Shaktikanta Das raised the amount of funds the central bank may absorb through its variable rate reverse repo – the jargon for excess funds that banks park with the central bank – but said that should not be read as the beginning of rolling back the accommodative stance, which has driven rates to record lows.

The Monetary Policy Committee (RBI) raised inflation forecasts for the fiscal year by nearly 60 basis points to 5.7%, citing high automotive fuel rates and soaring prices of industrial raw materials, but kept the growth rate projection at 9.5%.

A basis point is 0.01 percentage point.

“Continued policy support from all sides – fiscal, monetary and sectoral – is required to nurture the nascent and hesitant recovery,” Governor Das said. “The MPC continues to be conscious of its mandate of anchoring inflation expectations as soon as the prospects for strong and sustainable growth are assured.”

The policy repo rate, or the rate at which RBI lends to banks, is kept at 4% after the six-member MPC voted unanimously in favour of a status quo, while the reverse repo rate remains at 3.35%. A poll conducted by ET among 21 banks, funds and financial institutions indicated a status quo.

But one of the MPC members voted against keeping the accommodative stance for as long as necessary. The MPC minutes, to be released on August 20, would detail the dissent, but that may largely have to do with nuanced communication, an aspect earlier raised by external MPC member J.R. Varma.

“From a head-in-sand approach on higher inflation so far, this policy meeting finally saw some implicit acknowledgement that continued disregard for inflation ultimately comes at the cost of policy credibility and the markets, eventually exacting higher risk premia,” said Aurodeep Nandi, economist at Nomura Securities. “This was reflected in the dissent of one of the MPC members against the accommodative stance, (pointing to) the RBI’s (eventual) move to slowly start draining the liquidity swamp.”

The RBI has been battling between its mandate to anchor inflation at 4% and the need to revive the economy crippled by the pandemic. While the central bank has been liberal in keeping the market in excess liquidity, inflation has remained above the targeted 4%. However, the RBI has elbow room to move two percentage points in either direction. The governor acknowledged the balancing act.

“Before the onset of the pandemic, headline inflation and inflationary expectations were well anchored at 4%, the gains from which need to be consolidated and preserved,” said Das. “Stability in inflation rate fosters credibility of the monetary policy framework and augurs well for anchoring inflation expectations. This, in turn, reduces uncertainty for investors, reduces term and risk premia, increases external competitiveness and, thus, is growth-promoting.”

But the first contraction since independence due to lockdowns, the continued threat of the viral infections crippling economic activity and the fragile finances of many businesses have forced the central bank to keep inflationary concerns on the back burner and focus on strengthening growth.

“Inflation may remain close to the upper tolerance band up to Q2:2021-22, but these pressures should ebb,” with the arrival of seasonal farm produce, said Governor Das. “A pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions.”