Monetary Policy Review: Repo Rate Unchanged as RBI Maintains ‘Accommodative’ Stance

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Monetary Policy Review: Repo Rate Unchanged as RBI Maintains ‘Accommodative’ Stance

The Monetary Policy Committee (MPC) on October 8 kept the key lending rate, the repo rate, unchanged at 4 percent and retained the monetary stance as ‘accommodative’. An accommodative stance refers to the rate setting panel’s willingness to either cut rates or remain on hold. Repo is the rate at which the central bank lends short-term funds to banks.

This is the eighth consecutive time the MPC maintaining a status quo in rates.  "The RBI’s Monetary Policy Committee has decided to maintain the Repo Rate at 4 percent in the October policy. We also retain the ‘accommodative’ stance and will ensure that inflation remains within target range. The policy rate decision was unanimous, stance decision was 5:1," said Governor Das.

 

GDP estimates at 9.5% for FY22

The RBI maintained  FY 22 growth target at 9.5%. For Q1FY23, the central bank has GDP growth target at 17.1 percent.

Das said the central bank sees Q2FY22 GDP growth at 7.9 percent compared to 7.3 percent earlier; Q3FY22 GDP growth at 6.8 percent against 6.3 percent earlier and retained the GDP growth at 6.1 percent for Q4FY22.

"High frequency indicators suggest economic activity has gained momentum. Core inflation remains sticky. July-September Consumer price Index (CPI) inflation was lower than anticipated. India in a much better place today than at the time of the last MPC meeting," the Governor said

"Growth impulses are strengthening, inflation trajectory more favourable than expected. Pent-up demand, festival season should boost urban demand. Recovery in demand gathered pace in Aug-Sep. Pick-up in import of cap goods point to some recovery in activity," he noted.

Importantly, the RBI sounded optimistic on the growth recovery in Indian economy. On October 5, ratings agency Moody's hiked India's sovereign credit rating outlook to stable from negative, citing an improvement in the financial sector and faster-than-expected economic recovery across sectors.

In the last policy review, the MPC had retained the projection for real GDP growth at 9.5 per cent for 2021-22. Real GDP growth for the first quarter of 2022-23 is projected at 17.2 per cent.

In last MPC review in August, the central bank had kept key rates unchanged for the seventh successive time. It held the repo rate, its key lending rate, steady at 4 percent and the reverse repo rate, the borrowing rate, at 3.35 percent. RBI had last slashed the repo rate in May 2020 to a historic low of 4 percent to support the COVID-19 hit economy.

 

Retail inflation forecast lowered

At a time when crude prices are threatening inflationary pressure in the economy, RBI has thrown a surprise by lowering the consumer price index (CPI) or retail inflation projection from a high of 5.7 per cent to 5.3 per cent in the current fiscal.

It revised the inflation projection downward for the second quarter from 5.9 per cent to 5.1 per cent. The third quarter ( Oct-Dec) forecast has been revised from 5.1 per cent to 4.5 per cent. The fourth-quarter inflation projection has been kept at 5.8 per cent.

The central bank's confidence comes from the gradual decline in retail inflation from a high of 6.6 per cent in May to 5.3 per cent in August 2021.

The RBI is still maintaining that inflation is transitory and a temporary phenomenon because of supply-side shocks from the pandemic lockdowns.

Morgan Stanley Research also expects headline CPI to moderate to 4.3 per cent in September from 5.3 per cent in August, driven by base effect and low food inflation.  Most experts cite the easing of food inflation in view of comfortable Kharif food grains and also the rising number of vaccinations in the country as favourable factors for the downward inflation trajectory.

Crude oil  prices factor: But a section of the market is surprised as crude oil prices are already flaring up in the international market. Crude prices are currently close to $80 per barrel.

There is already a direct impact on the domestic petrol and diesel prices. Take, for instance, the petrol prices in Mumbai have breached Rs 109 per litre, while diesel prices increased to Rs 99.55 per litre.

The petrol and diesel prices are moving up across the country.  At some stage in future,  the high transportation charges are going to fuel inflation in food and other items in the second half of the current year.

More headroom for RBI to continue with the accommodative stance with lower interest rates: A lower inflation forecast provides headroom for RBI to continue with the accommodative stance with lower interest rates. The country's apex bank has been maintaining the repo rate at 4 per cent for the last year to support the industry as well as households and also support the overall recovery in the economy.

Retail inflation has averaged 6 per cent in the first pandemic year. The revised projection of 5.3 per cent in the current year is encouraging if it stays within the 6 per cent level.

"What we are doing is spreading the disinflation over a period of 2-3 years so that the losses of output are minimised. That's the inflation stance," says Michael D. Patra, RBI's Deputy Governor in the August policy.

Jayanth R. Varma, one of the MPC members, had warned in the August policy that the inflationary pressures are beginning to show signs of greater persistence than anticipated earlier.  "While there is some comfort that inflation is forecast to be below the upper end of the tolerance band, it is important to emphasise that the inflation target for the MPC is 4 per cent and not 6 per cent or even 5per cent," he said.

Varma added that the tolerance band is designed to allow for forecast errors, implementation shortfalls, and measurement issues. "Treating 5 per cent as the target would significantly increase the risk of inflation targeting failures," he noted.

If the oil prices continue to rise, the RBI will need support from the government in reducing cess and excise duties to reduce the cost pressures coming from oil prices. There are some estimates of oil touching $100 a barrel.

 

Ensuring ample liquidity to aid growth

RBI Governor Shaktikanta Das said the bank will ensure adequate liquidity to support growth. In the absence of further borrowing under GST and an increase in government spending, there is no need to further expand the GSAP operations, Das said. "The RBI will remain ready to undertake GSAP as and when warranted by liquidity conditions and will continue to undertake other liquidity management operations like Twist and OMOs," he noted.

GSAP is basically an unconditional and unstructured purchase of government bonds by the central bank from the market players. The measure was introduced by the central bank after its April monetary policy meeting in an effort to keep bond yields lower, which had surged in the run-up to the meeting amid inflation fears.

The central bank kept the key policy rates unchanged in an attempt to strengthen the speedy recovery of the economy. He mentioned that the 14-day variable rate reverse repo has been the key instrument under the liquidity framework and the potential liquidity overhang was over Rs 13 lakh crore, as the economy manifested signs of recovery from the COVID-19 pandemic.

"RBI has maintained ample surplus liquidity since the beginning of the pandemic for India's speedy recovery, with surplus increasing further during September under reverse repo," Das added.

Regarding the GSAP Das said, "This process has to be gradual, calibrated, and non-disruptive. GSAP has been successful, coupled with other liquidity measures that made recovery conducive.”

 

Exports

While exports have been encouraging and merchandise trade have rebounded, rising freight prices continue to pose a challenge.  “Buoyed by strong external demand and base effects, exports registered a sharp expansion in Q1:2021-22 and the buoyancy continued to Q2. Merchandise imports also rebounded strongly on the back of the recovery in domestic demand, higher crude oil prices and base effects,” the MPC report said.

Imports, however, surpassed exports and net exports contributed negatively to aggregate demand in Q1:2021-22 with -1.9 per cent in Q1 which was 1.3 per cent a year ago.

Meanwhile, engineering goods, organic and inorganic chemicals, petroleum products, cotton textiles and drugs and pharmaceuticals powered the merchandise trade. At the same time, labour-intensive sectors which includes leather products, apparels, and tea continue to lag, because of greater sensitivity to mobility restrictions.

“The persistent upsurge in global container freight prices and the growing shortage of semi-conductors, however, pose downside risks to a durable merchandise trade recovery,” it read. The report explained that the world is currently facing an acute shortage of semiconductors, which is the fourth most traded item globally after crude oil, refined oil and cars.

Shortage of semiconductors: The global semiconductor market is valued at $440 billion which accounts for nearly 5 per cent of global goods trade. The sector is expected to grow by 25.1 per cent ($551 billion) in 2021, courtesy of the rising demand for mobile phones, information and communications technology (ICT) infrastructure, personal computers, industrial applications, consumer electronics and automobiles.

“The buoyant demand for electronic gadgets, cloud computing solutions and auto industry following COVID-19 pandemic led to a huge supply-demand mismatch in the semiconductor industry, causing production delays and inflationary pressures across segments forcing companies to reinvent their supply chains,” it read.

Schemes to help achieve target of $400 billion for 2021-22: On an encouraging note, the report said that schemes such as PLI Scheme for sunrise sectors, District as Export Hub (DEH) covering One District One Product (ODOP) and Ubharte-Sitare scheme  for MSMEs should help in achieving the target of $400 billion set for 2021-22 and improve export competitiveness.

It also said that the PLI scheme and Scheme for Promotion of Manufacturing of Electronic Components and Semiconductors (SPECS) will encourage its domestic production of electronic goods.

Trade deficit: Meanwhile, the trade deficit jumped from $23.4 billion to $55.5 billion in April-August 2021 year-on-year. Still the number remained below its pre-COVID level ($ 77.2 billion).  Service sector  also saw a record growth in exports with its Q1: 2021-22 exports being the highest in 13 quarters and surpassing pre-pandemic levels.

The report attributes this growth to software, business, and transportation services.


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