By Pranjul Bhandari & Aayushi Chaudhary
The RBI policy was in line with our expectations on several fronts. One, it kept policy prices unchanged (repo price at 4%, reverse repo price at 3.35%), and stance accommodative “as long as necessary—at least during the current financial year and into the next financial year—to revive growth on a durable basis”. Both choices have been unanimous across the six MPC members.
Two, it raised its inflation forecast sharply, from 5% in H2FY21 to 6.3% (6.8% in 3Q and 5.8% in Q4), highlighting that the outlook has turned “adverse” relative to two months ago. While it did mention that cereal and vegetable inflation could ease, it highlighted that other meals things could stay inflationary for longer. It expressed worries on increasing oil costs and expense-push pressures feeding core inflation. We have been warning that inflation will stay larger for longer, led in portion by the disruption in India’s informal sector, which tends to make up half of the economy.
Three, it raised its development forecast as nicely, from a contraction of 9.5% in FY21 to a contraction of 7.5%. Interestingly, it now expects development to be constructive in the final two quarters of the fiscal year (+.1% and +.7% respectively).
RBI has been juggling competing objectives on inflation, bond yields and the rupee at a time when public borrowing is higher, and unconventional policies abroad are resulting in elevated inflows into the Indian economy. If it buys government bonds or dollars to maintain bond yields from increasing or the rupee appreciating in the midst of a development crisis, it will only add to elevated domestic liquidity, stoking inflation worries additional.
Markets have been hunting very carefully at today’s policy to get a sense of exactly where the balance across objectives will lie. And RBI created it all also clear, at least for now.
On the a single hand, it raised its inflation forecast, even calling its evolution “adverse”. But, on the other hand, it did not proactively announce any measures to drain liquidity or bring brief-finish prices back into the LAF corridor. As is nicely recognized, brief-finish dollars marketplace and T-bill prices have fallen nicely under the reverse repo price in current weeks.
RBI stated categorically that “the various instruments at our command will be used at the appropriate time, calibrating them to ensure that ample liquidity is available to the system … our paramount objective is to support growth while ensuring that financial stability is maintained and preserved at all times”.
As such, we think it sided much more with development recovery than with its inflation objective (of 4%, with a 2-6% tolerance band). This decision in our view was led by (1) a substantial government borrowing schedule for the year, which will want RBI OMO purchases and flush liquidity in order to be non-disruptive for bond markets, and (2) nonetheless weak development, regardless of the upward revision in the forecast, which may possibly want handholding for longer. Indeed, as we have explained just before, the official GDP estimates may possibly be overstating the true development on the ground, as they do not account for the informal sector appropriately
And however, policy priorities could alter subsequent year. With the coming of a vaccine, increasing recovery price and herd immunity in some components of the economy, activity could get a increase, specifically in the solutions sector, thereby driving up service inflation. And, we think RBI may possibly not be capable to ignore that in the face of increasing financial development.
We think that RBI will steer on a normalisation path in H1FY21, working with a host of instruments, ranging from wider participation of entities in the reverse repo window, holding variable reverse repo auctions at larger prices, setting up a a great deal-discussed SDF window to absorb surplus liquidity, raising the CRR price back up, and not replenishing the currency in circulation leakage. In truth, the use of many instruments may possibly be vital in the face of the not possible trinity which RBI is facing.
We want to emphasise right here that there is a lot RBI can do in the normalisation procedure, without having embarking on a price hiking cycle.
Co-authored with Priya Mehrishi, Economics Associate, HSBC Global Research
Edited excerpts from HSBC Global Research’s India’s RBI holds steady (dated December 4)
Bhandari is chief India economist and Chaudhary is economist, HSBC Global Research. Views are individual