MPC’s October meet may see more active debate on definition, pace, mode of accommodation

The August minutes of the Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) of the met on August 4, 5 and 6 were more hawkish than the policy itself. The MPC determines the policy interest rate required to achieve the inflation target.

The dissenters, Professor Varma and Dr Saggar and Dr Goyal, made a case for the co-existence of (liquidity/policy) normalisation and an accommodative stance.

The other takeaway was that the growth narrative was largely similar across the board, with members agreeing on the need for durable growth, though some split emerged on the persistence of inflation risks. We see FY22 inflation 30-35bps lower than what the RBI had projected.

‘Do not see reverse repo rate hike’

The October MPC may see more active debate on definition/pace/mode of accommodation. We expect variable reverse repo rates (VRRRs) to be gradually increased further, either on tenor or amounts. We do not see a reverse repo rate hike this year and see the RBI maintaining its preference for curve flattening.

The dissenters argued for a more judicious forward guidance.

The minutes of the August meeting was of particular interest because of Professor Varma's 'dissent', the second in one year. The unease of Professor Varma arose from his assessment that:

(1) COVID is pervasive and yet impacting only a pocket of the economy. But a generic accommodative monetary policy can’t be targeted (unlike fiscal) and thus it is largely fuelling asset inflation. Forward guidance and monetary stance are becoming counter-productive and will only increase inflation risk premium as well as term premium.

(2) MPC's inflation target is 4 per cent, not 5 per cent, not 6 per cent. The tolerance band is to allow for estimation errors and using this flexibility overly will only lead to inflation-targeting failures later (reminds us of Dr Patra’s narrative during former Governor Urjit Patel's days).

(3) Disagreement with the level of the reverse repo rate, though it does not fall under the MPC’s purview. He argued that a much-needed phased normalisation of the corridor would increase the MPC’s ability to keep the repo rate at 4 per cent for a longer period.

Interestingly, the other silent noises seen in the June minutes made their way again. Dr Saggar, while emphasising the need for durable growth and policy accommodation, admitted that the risk of policy errors on either side remains, given the large uncertainty on growth and inflation as well as policy trade-offs.

He thus made a case for policy agility, should the need arise. He later called for the need to avoid inflation risks when credit demand improves – swiftly making a case for non-disruptive gradual unwinding “when the time comes” – lest making markets complacent of flush liquidity.

We even had the usual dove, Dr Goyal, using the word ‘normalisation’, whenever it starts – extending the argument that other (liquidity) normalisation can start even in an accommodative stance.

The inflation transience continues but risks remain

The overall inflation and growth narrative was largely the same as the August policy. But there were mentions about the risks of inflation (and inflationary expectations) becoming more persistent from the so-called transient supply shocks and margin increases.

Case against higher administered fuel prices

The case against higher administered fuel prices was again stressed by a few members. Even as growth remains sub-par, Dr Patra noted that core inflation may stay sticky, given the COVID-related margin increases and tax hikes, even when some supply-side mismatches were easing.

The growth narrative was largely similar across the board, stressing on need for durability of recovery. Even the dissenter, Prof. Varma, agreed for a repo rate at 4 per cent on the back of sub-par growth, albeit arguing (along with Prof Goyal) that policy accommodation and liquidity normalisation can co-exist.

Governor Shaktikanta Das, on the other hand, argued that the risk- reward still favours maintaining congenial financial conditions and fiscal boosters.

Emerging differences may have implications for the October MPC.

While the predominant view remains the need to support recovery, the (dis)comfort with inflation dynamics is certainly dividing the MPC members.

The overall tone of the minutes is slightly more hawkish than the policy itself, but we still think state-based actions and guidance will lead the show in the end. We see inflation to be lower in FY22 (Emkay: 5.35 per cent; RBI: 5.7 per cent), which could give the RBI more room to manage expectations.

Interestingly, the core RBI MPC on net seems more convinced that normalising policy early would be a mistake – as was also seen in the recent bulletin authored by Dr Patra. It also argued the limited role of monetary policy to influence supply- driven inflation and more involved role of fiscal policy in the same.

The August minutes do little to change our view that the enhanced VRRRs to mop up liquidity are not to be seen as a reversal of policy stance but simply the normalisation of liquidity skewness. We expect VRRRs to be gradually increased further, either on tenor or amounts, to normalise liquidity skewness. We do not see a reverse repo hike this calendar year. We reckon the RBI will continue to strive to fix the artificially skewed yield curve and maintain its preference for curve flattening.

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