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Banking Central| MPC may hold its horses for now but what’s the guidance going to be on rates?

There is uncertainty on growth, inflation fronts. The policymakers do not have a clear direction on where to go on interest rates at this point.

April 05, 2021 / 08:37 AM IST
Reserve Bank of India (RBI) Governor Shaktikanta Das.

Reserve Bank of India (RBI) Governor Shaktikanta Das.

The MPC (monetary policy committee) will announce the outcome of the rate panel’s first meeting of FY22 on April 7. Noting much has changed from the last policy review for the MPC to change its rate stance. To put it in simple words, inflation threats remain and growth signals continue to be weak. That kind of uncertainty shouldn't ideally inspire confidence for the MPC to tinker with the rates. Hence, status quo, with a reiteration to act when needed, seems to be the only possibility. The MPC has cut the key lending rate, repo, by 250 bps since February 2019.

Theoretically, two scenarios where a rate hike is warranted is when inflation decisively moves up beyond the comfort zone of the central bank or when growth takes a firm footing. On the other hand a rate cut is called for when growth is on a steep fall requiring policy support (of lower rates to stimulate bank lending and demand) and when inflation is not a big worry (or well within the control in a stable manner). The MPC needs conviction to move on either direction. At this stage, there is none.

The Consumer Price Index (CPI) or retail inflation rate for the month of February 2021 surged to 5.03 percent, the Ministry of Statistics and Programme Implementation (MoSPI) said on March 12 triggered by rise in food inflation and fuel. On the other hand, the Index of Industrial Production (IIP) contracted by 1.6 percent in the month of January, as per the data released by MoSPI. As Lakshmi Iyer, CIO (Debt) & Head Products, Kotak Mutual Fund said in a note, “the last thing the central banker would want to do is tweak policy amid uncertainty. The case for maintaining adequate liquidity and gradual normalising over time remains.”

The MPC's primary mandate is to keep inflation within the prescribed and fix policy rates accordingly. The MPC, set up in 2016, has been given a freehand on the inflation targeting for the next five years at 4 per cent with 2 per cent deviation on either side. That's a good thing because the policymakers can focus on their assigned task of continuity in inflation fight. There were fears that the Government will arm-twist the panel to support growth.

But, Government's worry on growth is understandable. The situation is such that post Covid, inflation is not the primary concern of any central banker across the world but reviving the faltering economic growth is. In the minutes of the last MPC meeting, the members had clearly indicated that the focus of the panel largely continues to be on the same page with respect to the urgent need to support a faltering economy hit hard by the COVID-19 pandemic.

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It said the growth recovery may take longer time than initially expected in the absence of investments and systemic stress. Further, the comments of the members suggest that the panel could continue with the current accommodative stance for a longer period to support growth. Clearly, there is a larger worry on the resurgence of asset quality stress in the banking system.

Rates are only one part of the story. The bond market is more interested to know the RBI’s guidance on the liquidity management, primarily use of more open market operations (OMOs) to manage the borrowing programme and guidance on interest rates. The G-Sec yields have jumped post January and is expected to rise further in line with the rise in global yields. Where does the RBI want to take it? Will it continue to artificially keep the yields down by a series of back-to-back simultaneously bond purchase/sales?

With the focus remaining on growth, the MPC may also signal more fiscal help to kick off the investment cycle—through a combination of private and public investments. After all, the monetary policy has limited tools to support growth beyond facilitating lower rates and making liquidity available in the financial system. Only fresh investments can kick-start the economic engine again, revive consumer demand. Time and again, experts have pointed out absence of fresh investments as an impediment to growth.

To sum up, since its inception in 2016, the MPC has brought in more credibility to the rate setting process and more quality to the discussions. Yet, the best approach for the rate panel at this point is not to add further confusion in an already uncertain economic environment. The panel has to do a tight rope walk yet again balancing the growth-inflation trade-off.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)
Dinesh Unnikrishnan
first published: Apr 5, 2021 08:37 am

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