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RBI likely to maintain status quo for eighth time; steps towards policy normalisation key to watch

RBI’s monetary policy committee began its bi-monthly meeting on Wednesday

RBI-logo-Shutterstock Representational image | Shutterstock

The Reserve Bank of India’s monetary policy committee (MPC) began its three-day bi-monthly meeting on Wednesday.

A continued rise in oil and other commodity prices, which could pressure inflation in the coming months and in turn hurt consumer sentiments, will undoubtedly be a key issue on the table. However, the fall in COVID-19 cases, and vaccinations, which have picked up pace, should give some hope to the central bank that the economic recovery will gain traction.

The RBI, like other global central banks, had unleashed a slew of measures last year, including a sharp reduction in interest rates, in order to lift the economy, hit by the pandemic. RBI reduced the repo rate by 115 basis points since March 2020, in addition to 135 basis points rate cuts since February 2019. However, the central bank has maintained a status quo in the last seven policy meets, although there were some signals last time around that it may be beginning to take small steps towards normalising liquidity in the system.

Economists expect that the RBI will continue to hold the repo rate at four per cent in the current MPC meet too, but its outlook on the economy and inflation as well as commentary on liquidity management will be closely watched.

“The upcoming policy will be watched for the RBI’s stance on liquidity management. While the RBI may not shock the system with a reverse repo hike, the policy will be used as a lever to prepare markets for a gradualist approach toward normalisation through both communication and action,” said Madhavi Arora, lead economist at Emkay Global Financial Services.

In the previous MPC meeting in August, the central bank had announced four variable reverse repo rate (VRRR) auctions to mop up some of the excess liquidity in the system.

Last week, analysts at Citigroup had said the RBI may raise the reverse repo rate (the rate at which banks park excess liquidity with RBI)—currently at 3.35 per cent—by 15 basis points this time around. Although, Citi's views could be seen as an outlier.

Sonal Varma, chief India economist at Nomura Securities, expects RBI to raise the reverse repo rate by 40 basis points in the December policy meet and then a 75 basis points of cumulative repo and reverse repo rate hikes in 2022.

“We expect policy normalisation to begin with liquidity normalisation (October), narrowing of the corridor (December) and finally a change in stance and repo rate hikes (first quarter of 2022),” said Varma.

Suman Chowdhury, chief analytical officer, Acuite Ratings & Research, also believes that RBI will continue with an accommodative monetary policy this time around too, with further steps likely to be taken to recalibrate the excess liquidity in the system over the next couple of quarters.

“Central banks, like the Federal Reserve in US, have taken a stance to moderate surplus system liquidity in a gradual manner through a tapering of their aggressive bond purchase programmes instead of initiating interest rate hikes. We believe that RBI will also adopt a similar approach over the next two quarters to optimise the systemic liquidity position before considering any rate hike. With steady progress on vaccination and the pickup in aggregate demand, we expect RBI to start normalising the policy corridor from December 21 onwards through a reverse repo rate hike,” he said.

Chowdhury sees a repo rate hike in the April-June quarter of next year.

Retail inflation will be a key consideration on the MPC’s minds. The RBI has an inflation target band of two per cent to six per cent. The consumer price inflation in August moderated to 5.30 per cent, its lowest level in four months, largely aided by a fall in food prices. Fuel and transportation price levels have remained elevated though. Further, the recent surge in global energy prices, coupled with continued supply constraints, is also expected to add to the inflation, although lower food prices would offer some cushion.

“The MPC will likely caution on possible volatility in food prices later in the year amid an uneven temporal rainfall distribution, retail pass-through of the recent sharp rise in oil prices, consequent high household inflation expectations and sticky/higher core inflation amid the possible percolation of input costs to output prices,” said Arora.

In this backdrop, the MPC could continue to bat in favour of reviving the economy.

“Economic revival would continue to be the focus of monetary policy, despite concerns over price pressures. To this end, the easy monetary policy is to prevail i.e., low interest rate and easy liquidity conditions,” said Kavita Chacko, senior economist at CARE Ratings.

While the RBI would continue to maintain adequate liquidity in the system, it would try to manage it in a calibrated manner by conducting VRRR auctions for longer tenor and higher quantum, felt Chacko.

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