MPC Meet: Monetary Policy And The Art Of Guidance
Rate hikes are off the table. India’s Monetary Policy Committee committed to this at its policy meet in October, offering a rare time-bound guidance. The committee has “decided to continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year,” it said in its resolution.
Since then, growth has improved quicker than expected with second-quarter GDP contracting 7.5% after a 24% drop in the first quarter. Inflation, however, has not receded as quickly as the committee’s projections had suggested.
As such, the MPC is unlikely to have the option to cut rates further.
A Bloomberg poll of 29 economists showed that all expect a status quo on the repo rate. The benchmark policy rate has remained at 4% since May now, following a 115 basis point cut in rates since March, when the Covid crisis hit India.
Will Elevated Inflation Upend MPC’s Guidance?
With no change seen on rates, markets will parse the MPC’s statement for any signs that the committee is dithering on its commitment to maintaining an accommodative stance into the next financial year.
Kaushik Das, chief India economist at Deutsche Bank, expects the RBI to maintain an accommodative stance. “But the tone of the guidance is likely to turn more neutral relative to the October policy,” he wrote in a note on Wednesday. By February, “policy is likely to carry a more hawkish tone, if inflation prints continue to surprise to the upside, growth trajectory continues to look better-than-anticipated and prospects of receiving a credible Covid-19 vaccine becomes more certain by then,” he said.
CPI inflation was projected at 6.8% for the July-September quarter and was expected to range between 5.4% and 4.5% in the year’s second half. Price pressures, however, have not receded as quickly as anticipated. CPI inflation rose to a six-year high of 7.6% in October compared with 7.3% in September. It has remained above the MPC’s target for seven straight months.
An unfortunate confluence of supply-side shocks, both on food and core inflation, have set fire to the classic Phillips curve hypothesis that higher unemployment and low growth should be accompanied by lower inflation, said Aurodeep Nandi, India economist at Nomura.
The inflationary impact of factors like unseasonal rains, higher indirect taxes, or more expensive transportation costs since the pandemic, should gradually phase out as normalcy returns. Unless this leads to higher levels of inflation expectations or higher wage growth, the risk of generalisation of inflation remain relatively capped for now.Aurodeep Nandi, India economist at Nomura.
Having said that, the risk is that these supply-side dysfunctions are happening at a time when there is a massive demand contraction happening concurrently – effectively muting the latter’s latent disinflationary pressures, said Nandi. “By the time these shocks subside by next year, growth will most probably be registering a cyclical recovery, and the ‘golden period’ of growth-induced disinflation’ will have been lost.”
While RBI Governor Shaktikanta Das said the MPC would look through the current bout of inflation in order to support growth, economists question how far the inflation targeting committee’s tolerance can stretch.
“While it would be too early for a guidance volte-face by the MPC, inflation at about 160 basis points above the upper tolerance level will be too big an elephant to ignore,” Nandi said.
"We expect the RBI to stay on hold, maintain an accommodative stance and continue with its guidance on Friday," said Rahul Bajoria, chief India economist at Barclays.
Bajoria expects retail inflation to remain elevated for the next six months or so. “While it may dip in December and January, inflation is likely to go up again thereon.” As such, what will be most interesting is how the MPC will communicate the increase in inflation forecasts, while managing financial stability and with its goal of inflation targeting, Bajoria said.
Signalling Beyond The Repo Rate
While RBI may not want to hike the policy repo rate in a hurry, it could signal the beginning of the withdrawal of its post-Covid emergency stance.
For one, the RBI could move to absorb some of the excess liquidity. Apart from dialling down the dovish tone in the December policy, the RBI will likely announce some measures related to liquidity, said Das.
Measures could span a gamut of options ranging from an increase in the cash reserve ratio to special market stabilisation bonds issued to suck out additional liquidity or operationalising the standing deposit facility, where additional funds can be parked at lower rates without collateral.