MPC has charted a clear path to normalisation


The 4th bi-monthly Monetary Policy Meeting (MPC) for FY22 took place from 6-8 October 2021. There weren’t any surprises in Friday’s address by the RBI governor. RBI maintained the status quo, with the repo rate remaining unchanged at 4 per cent along with the accommodative stance. The Marginal Standing Facility (MSF) and reverse repo rates were also kept unchanged.

Inflation debate
RBI has lowered the inflation forecast for FY22 to 5.3 per cent from 5.7 per cent earlier. In August, the inflation rate as measured by the Consumer Price Index (CPI) registered a growth rate of 5.3 per cent, below the upper tolerance band of 6 per cent. The fall in food prices and the favourable base effect were the major factors pulling down the inflation rate to the comfortable range. With respect to RBI’s inflation forecast, inflation rate for Q2FY22 and Q3FY22 is at 5.1 per cent and 4.8 per cent, respectively before inching up to 5.8 per cent in Q4FY22. The inflation forecast for Q4FY22 closer to the upper tolerance band could be explained by the fact that the favourable base effect wanes out from December’21 onwards. Though the inflation forecast at 5.3 percent is a relief, the rising fuel prices could be a spoilsport. For instance, in August 2021, even when the overall inflation rate cooled off to 5.3 percent, fuel and light inflation remained sticky at 12.95 per cent. Fuel being a necessary commodity, the rising fuel prices can push the overall inflation upwards. It is in this context; RBI governor reiterated the need for calibrated reversal of the indirect taxes on fuels.

Liquidity normalisation
RBI governor stressed that the Central Bank won’t go for a sudden policy normalisation. He reiterated that the step towards normalisation would be gradual. In this background, to absorb the surplus liquidity in the system, RBI enhanced the limit of VRRR (Variable Rate Reverse Repo) auctions to 6 lakh crores by December’21, starting from 4 lakh crores October 2021. More importantly, the governor provided the calendar on VRRR, thereby clearly communicating RBI’s course of action. It is expected that the RBI would keep the repo and reverse repo rates unchanged in its next MPC meeting schedule for December. Though the economy is recovering, certain sectors are still lagging. In such a scenario, a hike in the repo/reverse repo rate won’t be well taken. And the Central Bank would continue VRRR route to absorb the excess liquidity in the system.

MPC has also decided to suspend the G-SAP programme, given the surplus liquidity in the system and the absence of additional borrowing by the government for GST compensation. This could bring some pressure on the bond yields. Similarly, global developments including, the Fed tapering, are also not in favor of the bond market. Yet, the Central government not raising its planned borrowing for FY22 could help keep the bond yields in check.

The major takeaway from the RBI governor’s address was the clear communication on the RBI’s course of action towards normalisation, and assurance that the RBI would continue with the accommodative till the economy shows a stable recovery path.

First published in Economic Times


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