RBI data dependent, each MPC meeting should be seen as 'mutually independent'

Successive meetings of the Monetary Policy Committee (MPC) are not linked to each other and only the Reserve Bank of India's (RBI) inflation forecasts at each meeting would determine the interest rate decision, according to a person familiar with the matter.

"Each monetary policy action should be treated on its own merits and as mutually independent. Each time it will be based on the forecast. We shouldn't try to second guess (what the MPC will do)," the person said on the condition of anonymity.

The RBI's surprise decision to raise the repo rate by 40 basis points to 4.40 percent on May 4 has led to talk in the market that further rate action is guaranteed at the conclusion of the MPC's next meeting, scheduled for June 6-8. This belief has been reinforced by expectations of headline retail inflation jumping to around 7.5 percent in April, data for which will be released on May 12.

Economists have penciled in a repo rate hike of anywhere between 25 basis points and 50 basis points on June 8. But, according to the person quoted above, the entire matter hinges on the RBI's inflation forecast.

"The whole framework of inflation targeting is based on forecast targeting. If the forecast suggests that the tolerance band is being breached big time, the RBI obviously will have to act because it knows its interest rate measures today will have an impact only 6-8 months down the line. But if the forecasts are benign, why should it act?" the person said.

"What will happen in June will be decided by the June forecast."

Pandemic reversal

In his statement on May 4, Governor Shaktikanta Das had said the 40-basis-point repo rate hike should be seen "as a reversal of the rate action of May 22, 2020".

Two years ago, in an outside-the-schedule move, the MPC had voted to cut the repo rate by 40 basis points to 4 percent. This followed another unscheduled meeting of the rate-setting panel in March 2020, which had resulted in a decision to cut the repo rate by a massive 75 basis points. As such, speculation has been rife that the repo rate could be hiked by 75 basis points in the next couple of meetings, which would complete the reversal of the rate cuts made during the pandemic.

However, the person familiar with the central bank's thinking said the reversal of the pandemic-related support measures, including the rate cuts and the stance of monetary policy, could take 1-2 years.

Commenting on the stance of monetary policy, the person said it could remain in its current form "till the ultra-accommodation is off".

The May 4 resolution of the MPC retained the language on the stance on remaining "accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth".

"First, the RBI needs to remove the pandemic measures. There is Rs 6.5 lakh crore coming into the Liquidity Adjustment Facility every day. No power on earth can withdraw that in a day. It has to be a multi-year process, maybe Rs 2 lakh crore at a time. A 50-basis-point hike in the Cash Reserve Ratio (announced on May 4) only removed Rs 87,000 crore," the person said.

When specifically asked if the stance of monetary policy could remain the same as it is currently until the end of 2023, the person said: "All possibilities are open. Everything is on the table."