Churchil Bhatt, Executive Vice President & Debt Fund Manager, Kotak Mahindra Life Insurance Company
Friday's Monetary Policy Committee (MPC) decision on the surface may appear to be just another "status quo" policy. But appearances can be deceptive, and in this case, it sure is. The announcement on Friday has decisively shifted the MPC’s focus to containing inflation, marking down growth as an important but second priority. Recent experiences of the West with stubborn inflationary pressures, price pressures from the Russia-Ukraine war, and narrowing the domestic output gap, have all contributed to this shift. While this may look like a small step in isolation, this marks the beginning of the end of the “pandemic era” monetary accommodation.
Outside of policy action, the MPC revised its CPI inflation projections higher by 120 bps to 5.7 percent, given the recent spike in commodity prices, but lowered its FY2023 growth projections by 60 bps to 7.2 percent. With respect to liquidity normalisation, the RBI redefined the liquidity adjustment facility (LAF) corridor with the introduction of the Standing Deposit Facility (SDF) and restored the width of the new LAF corridor to pre-pandemic levels of 50 bps. The SDF rate has been set at 3.75 percent, which will now act as the floor for overnight rates, thereby making the fixed reverse repo rate irrelevant. Meanwhile, the bond markets have been given some assurance in the form of a temporary held-to-maturity (HTM) limit hike to 23 percent, but there was no commitment on the government securities acquisition plan (G-SAP) or the open market operations (OMO) support.
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The RBI, in the recent past, had assured markets of a well-telegraphed and non-disruptive path to policy normalisation. True to its promise, the RBI has embarked on this journey with a measured approach. Unlike in other major economies, inflationary pressures in India, while threatening the MPC’s upper tolerance band, are still reasonably well contained. The RBI can, therefore, take its time and espouse a gradual approach in its fight against inflation. In other words, the RBI is in a fortuitous position by being on time.
While the RBI has time on its side, it has only a limited influence over most of the factors governing inflation. That is because the majority of the factors driving our domestic inflation today are external. Most other central banks, unlike the RBI, are behind the curve in their fight against inflation. Hence, many including the US Fed are in a hurry to tighten monetary conditions and even sacrifice growth to address this issue. In this process, while the growth sacrifice they make will be their own, any success they achieve in containing inflationary pressures will also help the RBI's cause. Having the luxury to tighten at a gradual pace allows RBI to benefit from their success at virtually no cost. Be it inadvertently, India may have outsourced part of its inflation management to those who are in a hurry to control inflation. In a sense, it seems only fitting that each economy's growth sacrifice remains commensurate with its failure to manage the inflation problem in time.
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Going ahead, we expect the RBI to change its accommodative policy stance to neutral. The path thereafter will most likely be towards moderate policy tightening, the extent of which will be determined by the then growth-inflation dynamics. Walter Heller, a leading American economist, wrote a paper titled “Will there be another crash?” in the 1980s arguing that advances in fiscal and monetary management make another crash highly unlikely. Like Heller, we too don’t expect a recession-like scenario anytime soon. But having lived through COVID-19, I wouldn’t be too sure of anything. A measured approach to normalisation, along with a neutral policy stance, will give the RBI just the kind of necessary flexibility it will need in these times of high uncertainty.
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