RBI’s 3-day Monetary Policy meet begins; repo rate cut not in sight on Oct 9

Given all such uncertainties, MPC’s August forward guidance on watching for a durable reduction in inflation seems suitable

By Upasna Bhardwaj

The Reserve Bank of India’s Monetary Policy Committee meeting, which got postponed last week as the government was in the process of finalising the new external members, is now scheduled to deliver its decision on 9th October. The biggest question facing the market participants will be the bend of the new external members given their diverse backgrounds ranging from a focus on macroeconomy to agro-economy to financial markets. However, we believe that appointment of the new members does not dilute the key mandate of the MPC in any way — keeping inflation within the target range. Since August, the MPC has signalled enough to suggest a status quo in the upcoming meeting, first through the policy statement and then the minutes.

Clearly, with inflation having remained elevated and sticky over the past few quarters and now expected to remain so in coming months, the MPC members will need to be more cautious. Moreover, the high-frequency data on economic activity has been suggesting some signs of revival indicating that with the -23.9%yoy GDP growth in 1Q, the worst is behind us. Nonetheless, the pickup remains uneven with significant sectoral divergences (within sectors and across sectors) risking India’s economic recovery towards a K-shape one. For FY21, we expect GDP to contract by 11.5%, with further risks on the downside depending on the evolution of further COVID infections and the limited room available with the government for any aggressive fiscal stimulus.

Meanwhile, the inflation trajectory too remains uncertain. While the favourable base effect should help CPI headline trend towards 4% in 3QFY21, we do not see it sustain at such levels. We expect March 2021 CPI inflation at ~5%. Further, core inflation has been rather sticky and elevated despite weak demand, in part led by excise duty hikes and gold price surge—the impact of which should fade off gradually. However, most of the easing in headline inflation is projected on favourable base effects and expectations of moderation in food prices as supply-side shocks ease which doesn’t seem to be materialising as of now. We expect September CPI at 7.18% (heavy rains have led to a spike in vegetable prices), as against our earlier expectation that inflation seems to have peaked in August at 6.7%.

Given all such uncertainties, MPC’s August forward guidance on watching for a durable reduction in inflation seems suitable. Such caution is expected to continue even by the new members in the near term. We, thus, see limited room for further easing, at least for now. Meanwhile, the MPC will continue to reiterate its accommodative stance and room for further ease, as and when the room opens up depending on the inflation and growth dynamics. Further, the RBI will need to continue to focus on managing the overall bond market supply pressures (both for the Centre and the States). We also expect the RBI to begin providing a much more transparent future guidance like Central Banks in the rest of the world to avoid dislocations in the market.

(Upasna Bhardwaj is Senior Economist at Kotak Mahindra Bank. The views expressed are the author’s own)

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