Inflationary pressures to weigh on RBI MPC

With a new variant of Covid-19 surfacing last month, economists now suggest that the central bank should wait for some more time before it hikes the reverse repo rate

The six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) is expected to keep interest rates unchanged for the ninth consecutive occasion when it meets to review the policy between December 6-8. The last time the policy rate was changed was in May 2020, when the repo rate was reduced by 40 bps (1 percentage point = 100 bps). The repo rate was kept unchanged at four per cent in the next eight policy review meetings.

The central bank has maintained an extremely accommodative monetary policy since the onset of the Covid-19 pandemic, that is, since March 2020. RBI has said that the accommodative stance will be maintained till growth revives on a durable basis.

While the stance has been accommodative, RBI has started to unwind some of the liquidity measures like the government securities acquisition programme (GSAP) as there was a huge liquidity overhang in the system.

A section of the market is expecting further measures to normalise the ultra-loose stance of the policy in the December review meeting. A hike in reverse repo rate, in particular, is on the cards. Jayanth Varma, the only MPC member who voted for changing the stance to neutral from accommodative in the last two policy reviews, talked about the need to restore the rate corridor to 25 bps with a hike in the reverse repo rate.

The gap between the reverse repo and the repo rate – which is known as the rate corridor – was widened in March and May 2020 policy reviews, to 65 bps, from 25 bps.

With a new variant of Covid-19, Omicron, surfacing last month, economists now suggest that the central bank should wait for some more time before it hikes the reverse repo rate.

The World Health Organisation has declared the new variant as ‘Variant of Concern’.

“We believe the talks of a reverse repo rate hike in the MPC meeting may be premature as RBI has been largely able to narrow the corridor without the noise of rate hikes and ensuing market cacophony,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.

Ghosh argued that nowhere in the MPC’s mandate is there any reference to its role in liquidity management, which remains internal to the functioning of RBI consistent with its policy stance, and that RBI is not obliged to act on reverse repo rate only in MPC

“…delaying normalisation measures is prudent in the current situation which would also give time for economic recovery to strengthen further,” Ghosh added.

Growth outlook

The country’s GDP grew by 8.4 per cent during the second quarter of the financial year on the back of a low base, data released by the government showed last week.

“Headline GDP is decent but continues to highlight some headwinds,” Yes Bank said in a report. “The concern however remains on the momentum of private consumption. Although private consumption increased by 9.2 per cent QoQ and 8.6 per cent YoY, it remains below the pre-pandemic level. Another drag on India’s growth recovery is net exports or ‘exports minus imports’ with overall imports far exceeding exports,” the report said. While there may be a case for halting the policy normalisation plan, growing inflationary pressure in the economy cannot be overlooked, economists said.

“There were growing expectations that in the December MPC meeting, RBI would hike the reverse repo rate to narrow the corridor between repo and reverse repo rate. However, the new Covid variant Omicron has again pushed the global and Indian economy to a state of uncertainty and nervousness,” said Rajani Sinha, Chief Economist and National Director - Research, Knight Frank India.

In such a scenario, RBI in its upcoming MPC meeting is likely to keep the rates on hold, Sinha added “The central bank will be concerned about inflationary pressure building in the economy. Currently, the upward inflation pressure is because of high commodity prices and supply bottlenecks. However, with economic growth gathering momentum, there is a threat of further demand-side pressure on inflation. We can expect RBI to start hiking rates from 2022,” Sinha said.

Inflation woes

Consumer price index-based inflation rose to 4.48 per cent in October compared with 4.35 per cent in the previous month despite favourable base effects as food prices inched up along with high input costs, fuel and commodity prices. While RBI had lowered inflation projection for FY22 to 5.3 per cent, from 5.7 per cent projected earlier, there is a growing consensus that inflation for the year will be closer to six per cent - the upper end of the central bank’s tolerance band.

There is a section of the market that believes RBI to go ahead with policy normalisation despite the concern over the new variant.

“As the cobwebs begin to clear on the policymaking front, world central bankers are grappling with the debut of the Omicron variant of Covid virus,” said Lakshmi Iyer, CIO – Debt and Head – Products, Kotak Mahindra Asset Management Company.

“The path to normalisation has begun across the world, including India, and is less likely to stop for now. We, therefore, expect a reasonably high chance of a 15/20bps hike in reverse repo rate – a start to reduce the gap between repo and rev repo rate. The policy stance may remain status quo and hinge on incremental developments in the near term,” Iyer said.

(The writer is a Mumbai-based journalist.)