Monetary Policy: Many Hurdles Along Road To Normalisation
India's Monetary Policy Committee kept interest rates unchanged for the seventh straight meeting. The repo rate was last reduced in May 2020, making this the longest stretch of status quo in the benchmark policy rate over at least the last twenty years.
Globally, a smattering of central banks have already been forced to to take preemptive action amid rising inflation. The RBI has so far resisted. "A preemptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions", said RBI Governor Shaktikanta Das in his statement.
But how much longer can monetary policy remain accommodative in India?
Writing On The Wall
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 markets eventually exacting higher risk premia, said Aurodeep Nandi, India economist and vice president at Nomura. This was reflected in the dissent of one of the MPC members against the accommodative stance, and the RBI’s move to slowly start draining the liquidity swamp.
However, the policy tried to tread a tightrope in attempting to differentiate its liquidity maneuvers from the accommodative policy rate stance. A similar balancing act was visible in its view that inflationary pressures remain temporary and that the growth recovery is still in its nascence.
Nevertheless if inflation continues to remain elevated, policy trade-offs between it and growth are likely to get increasingly complicated going forward, and eventual policy normalization remains a writing on the wall.Aurodeep Nandi, India Economist, Nomura
First And Early Signs Visible
Suvodeep Rakshit, senior economist and vice president at Kotak Institutional Equities said the RBI's decision to increase the quantum of variable rate reverse repo auctions is a early signal.
"We see this as the first signal towards calibrating liquidity. Tools like overnight VRR, further increase in quantum of VRRR and allowing non-bank participation in the VRRR could be the measures before the onset of policy normalization," Rakshit said.
It is unlikely that the RBI will change its stance in the October policy, although the split in voting pattern may widen. The start of policy normalization in the form of a hike in reverse repo rate could come around the December policy after risks of further Covid waves fade amidst higher vaccination and visibility of durable growth.Suvodeep Rakshit, Senior Economist, Kotak Institutional Equities
Normalisation Will Be Back-Loaded
We expect the RBI to implement a relatively quick normalisation cycle, but in our view it is still some way off, said Rahul Bajoria, chief economist at Barclays. This was reinforced by the governor in his statement today.
We believe the lag between communicating its intention to exit extraordinary accommodation and beginning the normalisation of policy will be small, Bajoria said. Once the growth recovery is sustainably underway, the bank’s hesitance to normalise monetary conditions may fade, he added.
In The Meantime, Inflation Continues To Pinch
Meanwhile, as growth gathers steam, persistently high inflation will likely fuel the debate over the MPC’s inflation-targeting credibility, Radhika Rao, economist at DBS Bank said. This, in turn, will necessitate a gradual removal of the extraordinary stimulus and measures introduced last year.
Inflation-adjusted real rates have been negative for more than a year, with the repo rate at 4%, eroding returns from bank deposits.
"Real incomes are also falling, particularly in midst of the pandemic. The bite is harder for the rural consumers where the terms of trade are turning negative as non-food inflation is rising at a faster clip than food (proxy for incomes), whilst fiscal support has been scaled back and the second wave has hit the rural areas more adversely," Rao said.
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