If RBI changes stance during August MPC, it will send mixed signal to market as fight against inflation continues, say economists

Reserve Bank of India

A change in the Reserve Bank of India (RBI)'s stance on monetary policy in August will send a confusing or mixed signal to the market when the top priority of the central bank is to fight inflation, say economists.

Elaborating on the matter, economists said given the RBI’s main focus is bringing down inflation to the targeted 4 percent threshold (currently it is well above that), a change in stance may not go down well.

India’s retail inflation rose to a four-month high of 5.08 percent in June compared to 4.75 percent in the previous month as food inflation galloped to 9.4 percent given the impact of heatwave on vegetables.

“RBI is expected to maintain the stance of withdrawal of accommodation since moving away from this stance will give confusing signals at a time when the battle against inflation is ongoing,” said Madhavankutty G Group Chief Economist - Manappuram Finance.

A change in stance at this point of time will confuse the market, because the current stance suggests that the RBI is prepared to expand money supply to boost economic growth and willing to cut interest rates. Meaning, a rate hike is ruled out in the current stance.

Some  economists also said that if the RBI changes its stance to neutral, it may reflect at a possibility of the central bank moving interest rates in any direction, depending on incoming data.

In the monetary policy poll of Moneycontrol, a majority of experts said that the central bank will maintain its ‘Withdrawal of Accommodation’ stance. However, four bankers expect the RBI to change stance to neutral.

Moneycontrol’s poll of 18 economists found that bankers and fund managers expect the repo rate to remain unchanged at 6.5 percent.

Some experts believe that a change in stance by the RBI will help them manage liquidity better.

“It will help them manage liquidity better. If we look at cost of liquidity measured by WACR (Weighted average call rate), it has come down, but does not reflect in the short-term curve,” said Deepak Agrawal, CIO-Debt at Kotak Mutual Fund.

Prashant Pimple, Chief Investment Officer - Fixed Income at Baroda BNP Paribas Mutual Fund said a change in stance to neutral will send a signal to the market that any permanent measure on draining liquidity is not on the cards and will give headroom to bankers to manage liquidity better.

In the last few weeks, liquidity in the banking system has been in huge surplus. Currently, liquidity in the banking system is estimated to be in surplus of around Rs 2.79 lakh crore. The central bank is constantly trying to suck it out. But the efforts are not bearing fruit.

Usually, higher liquidity in the banking system poses a direct threat to the inflation target and financial stability.

That said, despite higher liquidity in the banking system, Madhavi Arora, Lead Economist at Emkay Global Financial Services opines that the RBI will continue with VRRRs as of now, and may not resort to any blunt tools to counter the current liquidity surplus.

“We expect the surplus to be there comfortably in H1FY25,” Arora said.