Monetary Policy: MPC Maintains Status Quo On Rates; CRR Cut To Be Reversed

India’s Monetary Policy Committee kept its key policy rate unchanged even as inflation fell to within its comfort band. The RBI, however, announced a two-phase normalisation of the 100-basis-point cut in the cash reserve ratio announced when the Covid crisis hit. The CRR will rise from 3% now to 4% between March and May.

After the review, the MPC voted unanimously to keep the repo rate unchanged at 4% for the fourth straight meet since May. The central bank that controls the reverse repo rate separately decided to keep it unchanged at 3.35%.

A Bloomberg poll of 32 economists showed that five expected a rate cut while the remaining expected a status quo. The repo rate has been cut by 115 basis points since the pandemic hit in March.

The committee, however, maintained an accommodative stance.

The MPC’s review follows the presentation of the Union Budget, which pegged the fiscal deficit for FY21 at 9.5% and at 6.8% for FY22.

CRR Cut To Be Reversed In Two Phases

While keeping rates unchanged, the RBI decided to reverse the CRR cut announced in March 2020 after the Covid-19 crisis hit.

• The CRR will rise to 3.5% effective March 27
• It will rise to 4% effective May 22

In order to temper any adverse market reaction, RBI Governor Das said the normalisation of CRR will leave space for the central bank to put other liquidity management tools to work.

Das said the stance of liquidity management continues to be accommodative and in consonance with the monetary policy stance. The RBI stands committed to maintain adequate liquidity to ensure “congenial financial conditions”, he said, reiterating his stance from previous post-Covid policy statements.

He termed the perception of a reversal of the RBI’s liquidity support as a “market misconception’, saying the recently resumed variable rate reverse repo operations were always part of RBI’s liquidity framework.

Growth Outlook

Growth is recovering, and the outlook has improved significantly with the rollout of the vaccine programme in the country, the Monetary Policy resolution said. The Union Budget 2021-22 has introduced several measures to provide an impetus to growth, with the the projected increase in capital expenditure auguring well for capacity creation, it added. The recovery, however, is still to gather firm traction and hence continued policy support is crucial.

• Rural demand is likely to remain resilient on good prospects of agriculture.
• Urban demand and demand for contact-intensive services is expected to strengthen with the substantial fall in COVID-19 cases and the spread of vaccination.
• The fiscal stimulus under Atmanirbhar 2.0 and 3.0 schemes of government will likely accelerate public investment, although private investment remains sluggish amid still low capacity utilisation.
• The Union Budget 2021-22, with its thrust on sectors such as health and well-being, infrastructure, innovation and research, among others, should help accelerate the growth momentum.

Inflation Outlook

In its resolution, the MPC said the sharp correction in food prices has improved the food price outlook, but some pressures persist, and core inflation remains elevated. An unwinding of taxes on petroleum products by both the centre and states could ease the cost push pressures with pump prices of petrol and diesel at historic highs. “What is needed at this point is to create conditions that result in a durable disinflation,” the resolution stated. This is contingent also on proactive supply side measures, it said.

• With the larger than anticipated deflation in vegetable prices in December, it is likely that the food inflation trajectory will shape the near-term outlook.
• The bumper kharif crop, rising prospects of a good rabi harvest, larger winter arrivals of key vegetables and softer egg and poultry demand on avian flu fears are likely to help keep inflation benign.
• The outlook for core inflation is likely to be impacted by further easing in supply chains; however, broad-based escalation in cost-push pressures in services and manufacturing prices due to increase in industrial raw material prices could impart upward pressure.

The central bank, according to the RBI governor, continues to see inflation targeting as the appropriate framework for monetary policy. His comments come ahead of a scheduled review of the inflation target in March this year.

Economist Views

The art of managing ‘RBI liquexit’ required words as much as action. On both, the RBI largely lived up to expectations, and in some aspects exceeded it, said Aurodeep Nandi, India economist at Nomura. The RBI clearly communicated that it doesn’t intend to yank away the liquidity carpet in a way that topples the vases of growth recovery and fiscal financing resting on it, he said.

In the midst of this, the status quo in policy rates and dovish policy stance, according to Nandi, correctly takes into cognizance the current growth-inflation dynamics and has been in line with expectations.

Radhika Rao, economist at DBS Bank, however, said the resolution did not have any outsized response to the jump in FY22 bond issuance as bond markets met some support by an extension of the HTM (held to maturity) enhancement to March 2023, and widening the investor pool by allowing retail investors direct access. An explicit OMO/OT announcement was absent, leading to a bearish reaction in bond prices.

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