PremiumThe MPC clearly stated that while inflation is likely to remain elevated and has constrained monetary policy space at the moment to support growth, recovery in the economy is still not broad-based and are dependent on sustained policy support
Macroeconomic backdrop had been complicated for the monetary policy committee (MPC) ahead of the December meeting. In the previous policy meeting in October, the guidance to “continue with the accommodative stance of monetary policy as long as necessary – at least during the current financial year and into the next year – to revive growth on a durable basis" came in as an unusually strong and explicit commitment to support growth recovery. The MPC decided to look through the current inflation hump which it believed to be transient.
Since then, a number of high frequency indicators demonstrated greater strength, along with better-than-expected corporate results during Q2 FY 20-21 and considerable narrowing in GDP contraction. This emboldened the RBI to revise their FY 20-21 GDP forecast to a contraction of 7.5% (from a projection of 9.5% contraction with downside risks in October). However, the CPI trajectory sprang fresh upside surprises since the last MPC meeting with the latest print coming in at 7.6%, markedly higher than the RBI’s upper tolerance band of 6%. This has prompted the RBI to materially revise their CPI inflation target upwards for H2 FY 20-21, from their previous forecasts.
Against this backdrop, it was nearly certain that the key policy rates would stay unchanged in December along with no change in the “accommodative" policy stance of the MPC. However, given the discernible upside surprise in inflation of late and given that now the MPC is dealing with the first spell of “failure" (i.e., failing to maintain CPI inflation within 6% for three consecutive quarters or more) since the adoption of the inflation targeting framework in 2016, there was a concern if that could lead to a dent in the RBI’s support towards growth.
However, it is heartening to note that the central bank’s commitment to growth recovery stayed equally strong in today’s policy as well. The MPC clearly stated that while inflation is likely to remain elevated and has constrained monetary policy space at the moment to support growth, recovery in the economy is still not broad-based and are dependent on sustained policy support. Accordingly, governor Shaktikanta Das made it explicit that his paramount objective at this moment is to support growth despite revising the forecasts of both inflation and GDP materially higher in today’s policy. Despite large systemic liquidity, the RBI’s commitment to continue with liquidity support was emphatic and encouraging as the central bank reassured that it stands ready to undertake further measures as necessary to assure market participants of access to liquidity and easy financing conditions.
After introduction of the “on-tap" TLTRO in October, it is encouraging that now the central bank allowed the 26 stressed sectors identified by the Kamath Committee to benefit from the same. This should help the TLTRO be more effective with a wider reach. The RBI also rightly allowed Regional Rural Banks to participate in LAF, MSF and call money markets as both lenders and borrowers – this should help better liquidity management for them and, in turn, better credit flow at the lower end of the pyramid.
While growth turned out to be better than expected of late, one feels that It might be prudent to continue watching some of the high frequency indicators closely, and an uneven pace of recovery remains more likely in the near future. Several on-ground anecdotes – such as uneven festive season sales momentum, inventory position with dealers in various industries, packaging industry demand – support that view. Overall, the RBI has rightly pointed out that growth recovery needs continued policy support and today’s policy statement once more emphatically reiterated their commitment in this regard.
The author is chief economist and head of research in Bandhan Bank. Views are personal.
