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The status quo on the repo rate with unanimous voting by all the monetary policy committee (MPC) members was on expected lines. While the 5-1 split in voting as regards the policy stance persisted and the global macro backdrop gets materially complicated, it is noteworthy that the MPC emphatically reiterated maintaining an “accommodative stance as long as necessary". The tone of RBI’s commentary appeared more dovish than expected, even though the central bank clearly embarks on a gradual withdrawal of the crisis-time liquidity support.

Overall, it once more underscored that policy normalization has started, with a gradual withdrawal of “excess" liquidity in the banking system, logically likely to be followed by normalization of the policy rate corridor by raising the reverse repo rate.

However, the MPC will likely show far greater caution and patience in hiking rates. The central bank’s message consistently emphasized on nuanced and data-dependent policy moves, rather than rocking the boat.

The October MPC meeting took place against an interesting backdrop of diverging global and domestic macro trends. On the domestic front, since the August meeting, the covid wave ebbed further and vaccination coverage widened significantly, leading to better near-term growth prospects. Inflation prints also softened to fall within RBI’s tolerance band and provided an immediate breathing space for the MPC. Rating agency Moody’s changed India’s rating outlook to ‘stable’ from ‘negative’.

However, the global backdrop was much different, fraught with major supply and logistics bottlenecks for industrial raw materials, fuel and energy in a number of leading economies, especially in recent weeks. A fresh rise in covid infections in various countries, even with those with high vaccination rates, is also visible. This poses major risks to both near-term growth and inflation dynamics. The likelihood of less accommodative monetary and liquidity conditions in the developed countries, including in the US, in the coming months have triggered a material rise in bond yields and weakening in emerging market currencies.

RBI unsurprisingly maintained its GDP growth forecast of 9.5% for 2021-22, with the modest undershooting of Q1 GDP expected to be broadly compensated by a tad better growth during Q2 and Q3. Indeed, improvement in the covid scenario since June has been quicker than expected, leading to sharp easing in mobility and logistics-related bottlenecks and gradual improvement in business and consumer confidence.

Nevertheless, the seemingly high 2021-22 growth expectation of 9.5% cannot undermine the need for continued policy support, as this is also a function of an abysmally low base of the previous year. India’s GDP is virtually in the middle of a phase of zero growth over a two-year period.

On the other hand, the MPC’s lowering of the 2021-22 average CPI (consumer price index) projection to 5.3% from 5.7% earlier came in as a surprise. Admittedly, CPI prints during July and August—which averaged below 5.5%, nearly one percentage point lower than in the previous two months—clearly offered a bit of near-term relief. However, given a large number of fresh uncertainties, including higher commodity prices (e.g., energy, food and metals), elevated energy prices at home and patches of unseasonal rains closer to the harvest season for the summer crop, risks on the inflation front in the near term are significant, multi-dimensional and largely beyond the direct influence of monetary policy. Thus, despite the lowering of the baseline inflation expectation, it is important to stay prepared for a wide fan chart for inflation in the coming months.

Despite relatively dovish commentary, RBI’s action and messaging clearly suggests continued focus on a gradual withdrawal of crisis-time liquidity from the banking system. While lowering the quantum of government securities acquisition programme (G-SAP) was a clear possibility, Friday’s announcement of refraining from further G-SAP in the near term came as a surprise. The second consecutive occasion of a high cut-off yield in variable rate reverse repo (VRRR) auction is also a significant signal.

Against that backdrop, a gradual uptick in bond yields towards the 6.50% mark over the coming months cannot be ruled out.

RBI’s actions on the liquidity front may overpower the status quo on policy rates in the near term. Possible relief, if any, on this front may come from either material lowering on inflation risks and/or concrete developments on inclusion of Indian bonds in global indices, about which the central bank sounded optimistic.

Siddhartha Sanyal is chief economist and head of research at Bandhan Bank. The views expressed here are personal.

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