The Monetary Policy Committee (MPC) on Friday left the policy repo rate unchanged at 4 per cent, for the third time on the trot. This was widely expected given the sticky retail inflation which, in the RBI’s view, is likely to remain elevated.
However, to support the nascent recovery in the economy, the six-member MPC persisted with its accommodative stance and decided to continue with it for as long as necessary to revive growth on a durable basis.
The MPC forecast the retail inflation to hold above its midpoint target of 4 per cent in the second half of 2020-21. Its members unanimously voted to keep the policy rate unchanged.
With the outlook for inflation turning adverse relative to expectations in the last two months, the MPC projected CPI (consumer price index) inflation at 6.8 per cent for Q3 FY 21 and 5.8 per cent for Q4 FY21.
The CPI inflation for the first half of FY22 has been forecast at 4.6-5.2 per cent, with risks broadly balanced.
Room for rate cut in Q1
Going by these projections and the MPC’s objective to achieve CPI inflation of 4 per cent within a band of +/- 2 per cent, room to cut rates may be available only in the first quarter of FY22.
“Further efforts are necessary to mitigate supply-side driven inflation pressures. The MPC will monitor closely all threats to price stability to anchor broader macroeconomic and financial stability,” said RBI Governor Shaktikanta Das.
Das emphasised that data available for Q3 FY21 confirm that the economy is recuperating faster than anticipated and more sectors are joining the multi-speed upturn.
The MPC projected real GDP contraction in FY21 to be lower at 7.5 per cent against the earlier projection of a decline of 9.5 per cent.
‘Will serve markets well’
Commenting on the RBI move, State Bank of India Chairman Dinesh Khara said: “The RBI policy of maintaining the status quo was expected but the continued forward guidance of an extended accommodative stance will continue to serve the markets well. The upward revision of the FY21 GDP growth rate to -7.5 per cent emphasises that the worst is behind us, though we must remain watchful.”
Contrary to expectations of measures being announced to absorb excess liquidity, the RBI promised continued liquidity support.
Multiple objectives
The RBI has been facing a tough task of juggling between various objectives — inflation, rupee, bond yields and liquidity. A large government borrowing this fiscal year has prompted it to step up outright OMOs (purchase of government bonds) to keep bond yields under check. But this has led to an increase in liquidity.
Importantly, strong foreign flows have led to the RBI buying dollars to keep the rupee from appreciating. But this has only exacerbated the liquidity glut, stoking inflation concerns.
The central bank has leaned more towards its objective of supporting growth rather than addressing high inflation. Managing long-term yields (to keep borrowing costs low), in view of the large government borrowing, also appears to top the RBI’s agenda for now.
“The absence of any major liquidity absorption measures in the midst of a prolonged inflationary episode and indeed the upward revision of both the RBI’s growth and inflation forecasts might be somewhat puzzling,” observed Abheek Barua, Chief Economist, HDFC Bank.
“However, it could mean that the RBI is still cautious about the durability of growth... (and) sees inflation as principally a supply-side problem,” he added.