The Reserve Bank of India’s monetary policy committee on Friday unanimously left the benchmark repo rate unchanged at 4 per cent and it also voted 5:1 to maintain the “accommodative” stance. The RBI noted a moderation in food inflation, but also cited pressures due to a surge in crude oil prices. Similarly, while economic recovery is picking up pace, aggregate demand, though improving, remains sticky, it said.
Most economists had expected the central bank to maintain status quo this time around and slowly over the next few quarters start reversing the abundant liquidity that it has infused in the system through the COVID-19 pandemic.
This is the eighth time that the RBI has left its key interest rate, at which it lends banks, unchanged. The reverse repo rate has also been kept on hold at 3.35 per cent.
RBI Governor Shaktikanta Das noted that the worst of the second wave of the pandemic was behind us and there had been a substantial pick-up in COVID-19 vaccinations, giving greater confidence to open up and normalise the economic activity and the recovery in the economy was gaining traction.
He also noted that economic activity in the past two months had broadly evolved in consonance with the monetary policy committee’s assessment in the earlier meeting in August and consumer inflation in July-August had also been lower than anticipated. This is why the central bank chose to maintain the benchmark interest rates as well as the accommodative policy stance, so that it can continue to focus on reviving and sustaining this growth as long as necessary.
“High-frequency indicators for Q2 (Jul-Sep) 2021-22 suggest that economic recovery has gained
momentum, supported by ebbing of infections, the robust pace of vaccination, expected record kharif foodgrains production, government’s focus on capital expenditure, benign monetary and financial conditions and buoyant external demand,” said Das.
The RBI has a target to maintain inflation around 4 per cent, in the 2-6 per cent range. Retail inflation in August moderated to 5.30 per cent, its lowest level in four months.
Improvement in monsoon in September, the expected higher kharif production, adequate buffer stock of foodgrains and lower seasonal pick-up in vegetable prices are likely to keep food prices muted, feels Das. However, elevated prices of crude oil and other commodities globally, coupled with acute shortage of key industrial components and high logistics costs are adding to input pressures, he said.
“Overall, aggregate demand is improving, but slack still remains; output is still below pre-pandemic level and the recovery remains uneven and dependent upon continued policy support. Contact-intensive services, which contribute about 40 per cent of economic activity in India, are still lagging. Supply side and cost push pressures are impinging upon inflation and these are expected to ameliorate with the ongoing normalisation of supply chains,” said Das.
He again reiterated that a calibrated reversal of indirect taxes on fuel could contribute to a more sustained lowering of inflation.
In this backdrop, the MPC has retained its GDP growth forecast for the current year ending March 2022 at 9.5 per cent, with expected growth of 7.9 per cent, 6.8 per cent and 6.1 per cent in the second, third and fourth quarters, respectively, of the year. GDP growth in the first quarter of next financial year is seen at 17.2 per cent.
The RBI sees retail inflation at 5.3 per cent in 2021-22; CPI inflation is likely to be around 5.1 per cent in the September quarter, falling to 4.5 per cent in October-December and again rising to 5.8 per cent in the March quarter.
“We are watchful of the evolving inflation situation and remain committed to bring it closer to the target in a gradual and non-disruptive manner,” said Das.
As the COVID-19 pandemic hit in February 2020, the central bank announced a slew of measures. A key initiative has been to maintain abundant liquidity in the system to ensure that the sectors in need are not starved of funds. The surplus liquidity has continued to rise over the last few months. So far this month (as of October 6), surplus liquidity rose to a daily average of Rs 9.5 lakh crore.
In April this year, the central bank had announced a secondary market government securities acquisition programme (G-SAP). In the first six months of the current financial year, the total liquidity injected into the system through open market operations, including G-SAP, was Rs 2.37 lakh crore, versus Rs 3.1 lakh crore in 2020-21 financial year. Given the existing liquidity overhang, the absence of a need for additional borrowing for GST compensation and the expected expansion of system liquidity as government spending increases in line with budget estimates, the RBI now doesn’t see a further need to undertake G-SAP operations.
“As the economy shows signs of emerging from the COVID-19-inflicted ravages, a near consensus view emerging among market participants and policy makers is that the liquidity conditions emanating from the exceptional measures instituted during the crisis would need to evolve in sync with the macroeconomic developments to preserve financial stability. This process has to be gradual, calibrated and non-disruptive, while remaining supportive of the economic recovery,” said Das.
At the same time, the RBI will undertake 14-day variable reverse repo rate (VRRR) auctions on a fortnightly basis, starting with Rs 4 lakh crore on Friday, Rs 4.5 lakh crore on October 22, Rs 5 lakh crore on November 3, Rs 5.5 lakh crore on November 18 and Rs 6 lakh crore on December 3 to mop up surplus liquidity.
Still, the RBI will ensure there is adequate liquidity in the system to support sectors in need.
The RBI extended the facility of special three-year, long-term repo operations (SLTRO) of Rs 10,000 crore at the repo rate for small finance banks till December 31 from earlier deadline of October 31, citing need for continued support to small business units.
Bank lending to registered non-bank finance companies (other than micro-finance institutions) for on-lending to agriculture micro, small and medium enterprises and housing was permitted to be classified as priority sector lending from August 13, 2019, to September 30, 2021. This facility also has been extended to March 31, 2022.
