RBI likely to keep rates unchanged on October 8, may provide roadmap on liquidity management

The six-member Monetary Policy Committee (MPC) is expected to meet for three days starting October 6. RBI Governor Shaktikanta Das will announce the decision taken in the meetings on October 8.

In the bid to contain inflation and spur demand, the Reserve Bank of India (RBI) is likely to maintain status quo on interest rates and keep the accommodative stance in its upcoming bi-monthly monetary policy (MPC) review, as per experts.

But traders and analysts are seeing hints that the central bank is seeking to drain record liquidity from the banking system, as it is increasingly shifting its forex intervention to the forwards market.

Earlier this month, the apex bank governor Shaktikanta Das had said, "As markets settle down to regular timings and functioning and liquidity operations normalise, the RBI will also conduct fine-tuning operations from time to time as needed to manage unanticipated and one-off liquidity flows so that liquid conditions in the system evolve in a balanced and evenly distributed manner."

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. This will be the eighth time that RBI maintains its stance if it decides to keep the rates unchanged.

The six-member Monetary Policy Committee (MPC) is expected to meet for three days starting October 6. RBI Governor Shaktikanta Das will announce the decision taken in the meetings on October 8.

Experts’ Speak

Pankaj Pathak, Fund Manager at Quantum Mutual Fund, believes that RBI will maintain the status quo on policy rates but it may change the forward guidance somewhat to prepare for a reverse repo rate hike by December policy.

“Given the core liquidity surplus is persisting close to Rs. 12 trillion, the RBI may provide a roadmap on liquidity management. However, we do not expect any immediate durable liquidity absorption measure at this juncture as it could raise speculative market actions. The RBI may restrict further liquidity infusion and rely on liquidity neutral instruments to intervene in the bond and forex markets,” he said.

Pathak added that the guidance on liquidity will be the key driver for the short tenor bonds, while the longer maturity bonds will depend on the quantum of GSAP (RBI’s bond-buying) in the second half of the fiscal. “Given the government borrowing is lower in October 2021 to March 2022 period; we should expect some reduction in the GSAP program in Q3 FY22.”

Suman Chowdhury, Chief Analytical Officer, Acuité Ratings and Research seconded Pathak’s seconded Pathak’s views on maintaining policy rates adding that the central bank can take some steps to recalibrate the excess liquidity in the monetary system over the next one or two quarters.

“While the high frequency indicators for the month of Aug-Sep’21 reveal that economic activity is reaching its pre-pandemic levels and the risks of another wave of COVID are gradually on a decline, the recovery momentum is still uneven and not well anchored across all sectors of the economy,” he noted.

According to Chowdhury, the combination of elevated global commodity prices, COVID related disruptions, vaccination progress, and policy support led economic revival have resulted in an acceleration in inflation in most of the developed and developing markets.

However, RBI believes the rise in inflation as ‘transitory’. In August, the central bank had increased the retail inflation estimate for the financial year 2021-22 to 5.7 percent from 5.1 percent projected earlier while retained the GDP growth target for the financial year at 9.5 percent.

The government, in March, had asked the RBI to maintain retail inflation at 4 percent with a margin of 2 percent on either side for a five-year period ending March 2026.

“Increasingly, the central banks like the Federal Reserve in US have taken a stance to moderate surplus system liqudity in a gradual manner through a tapering of their aggressive bond purchase programmes instead of initiating interest rate hikes. We believe that RBI will also adopt a similar approach over the next two quarters to optimise the systemic liquidity position before considering any rate hike,” Chowdhury said adding the he expects the RBI to start normalising the policy corridor from December 2021 onwards through a reverse repo rate hike which will likely be followed by an eventual hike in the benchmark repo rate in Q1FY23.

According to Rahul Bajoria, Chief India Economist at Barclays, while inflation has surprised to the downside it is not enough to rule out possible spikes in the future. “We expect the RBI to reduce its near-term inflation forecast, even as it remains vigilant of evolving price risks over the medium term. Elevated fuel prices, higher household inflation expectations, ongoing supply disruptions and a revival of pricing power remain key risks,” he said.

While Bajoria acknowledged the increased liquidity but said that does not mean that RBI is “in a hurry to drain liquidity.”

“We think policymakers will opt to rely on natural drainers such as increasing demand and currency outflows. Liquidity-neutral tools like operation twist are likely preferred, even as the central bank continues to send yield signals through its bond issuance program,” he noted.

While COVID-19 wave remains under control and the vaccination drive has gained critical mass in the country, RBI is expected to remain vigilant over possible downside risks due to a third COVID wave. The apex bank's former deputy governor R Gandhi reiterated RBI’s low-interest rate regime that is expected to continue to support the economic activities.

"In my assessment, normalisation or monetary policy tightening in India is several quarters away. Definitely, not in the current fiscal. Economy is reviving but we have not reached the absolute pre-COVID level of 2019-20," Gandhi said at an event organised by the Bengal Chamber of Commerce and Industry in September. "RBI will do (monetary policy tightening) when the economy will be growing sustainably," he said.