Home / Opinion / Columns /  RBI’s monetary policy stance will balance growth revival

Communicating the policy stance and providing forward guidance will be the toughest tasks for the monetary policy committee (MPC) in this week’s policy review. We expect a unanimous decision on holding the policy repo rate, although the tone on continuing an accommodative stance “as long as necessary to revive and sustain growth on a durable basis… while ensuring that inflation remains within the target" will be moderated, and the parsing will be of interest.

We begin with reaffirming our recognition of the exceptional innovation and dynamism of the Reserve Bank of India’s response, supported by the government. Economic conditions seem to have markedly improved since the last MPC preview in early June. Yet, price pressures are now a cause for concern.

First, on the global front. Global central banks, especially the Fed, might announce and then start tapering sooner rather than later, although spillover effects on emerging markets are likely to be more moderate than in 2013. Some of the smaller central banks have already started policy normalizations. The July US non-farm payroll (NFP) data will provide more clarity on job market tightness.

In India, there is a possibility of a third wave, although this is forecast to be moderate. 47 crore adults have been vaccinated, and supplies are gradually improving. The latest June-July ICMR national sero-prevalence survey shows antibody presence in 68% of 29,000 people sampled, indicating a measure of resistance to infections.

We continue with our 9.5% FY22 real GDP growth forecast, although there are emerging signs of an upside. In the near term, economic recovery seems stronger than earlier anticipated, given the narrative of economic scarring during the second wave. Axis Bank Composite Leading Indicator Index shows activity revival in July almost at March levels. Rains had been a concern, but the deficit now is largely covered across most geographies. Sowing for a couple of crops (oilseeds, pulses) is still lagging, but the gap looks to be closing. Demand recovery signs are strong. July manufacturing purchasing managers’ index (PMI) reads 55.3 (vs 48.1 in June), to a large extent export-led. July auto sales reported mostly double-digit growth. Even CV sales (especially LCVs) are recovering, despite issues with BS-VI transition. Dealer calls suggest that consumer durables demand remains robust, particularly from tier-1 and 2 cities. Residential housing demand remains strong across metros and large cities.

Central government spending will be able to support demand revival, although state governments remain fiscally constrained despite strong fuel sales tax collections. Direct tax collections, particularly corporate taxes, have been strong in Q1. GST collections in July (reflecting June activity) was 1.16 trillion, well above the monthly 1 trillion benchmark.

Inflation is emerging as a concern and it will be progressively difficult for the MPC to “look through". Post May and June CPI 6.3% readings, July and August prints are also likely to be sub-6%, but still high. Crude prices are likely to remain $75/bbl or above, given low inventories and tight demand-supply gap. Fortunately, food price inflation concerns seem to be moderating. However, corporate results seem to suggest that even downstream sellers (B2C) are passing on high input costs to end consumers, suggesting latent purchasing power.

While the RBI’s earlier 9.5% growth forecast is likely to be retained due to the emerging public health uncertainty, the average FY22 CPI forecast might be raised from 5.1% to close to 5.4%. RBI survey results of both household inflation expectations and industry capacity utilization will inform the MPC’s forward guidance.

The MPC statement will likely continue with an accommodative stance, but with a perceptible shift in tone. The RBI’s economic forecasts will also provide de facto forward guidance on the evolving growth-inflation trade-off. While data dependence will guide future actions, the RBI is likely to provide sufficient advance signals of normalization to ensure that financial markets continue to transition to tighter conditions in an orderly fashion, consistent with the governor’s oft-stated view of the sovereign yield curve being a public good.

Although hikes in the reverse repo rate might still be some time away, a de facto policy normalization will likely begin with a gradual draining of system liquidity without disrupting markets. Measures for calibrating both the price and quantity of system liquidity, designed to push up short-term rates, will be gradually introduced. The preferred instrument is likely to be offered amounts and pricing of longer maturity variable rate reverse repo auctions.

Finally, access to credit, particularly for MSMEs, remains key for sustained growth. Credit offtake from the system remains moderate, despite signs of revival of private sector capex in some segments. The emergency credit line guarantee scheme (ECLGS) has reportedly been effective in stabilizing the solvency (and cash flows) of micro and small businesses and progressive expansion of the scope will help stressed sectors. We expect further RBI measures to incentivize credit offtake.

Saugata Bhattacharya is executive vice-president (business and economic research) at Axis Bank. The views expressed here are personal.

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