At last week’s monetary review, the monetary policy committee (MPC) jolted the rate environment by resetting the policy priorities to inflation before growth, an oblique increase in the reverse repo rate, and an open field for future policy actions as befits a highly uncertain price environment.
None of this was anticipated. The punch was forceful and the bond market reacted to that as well as what had been expected, viz., forecast revisions that now see inflation 120-basis points higher at 5.7 percent in FY23, and real GDP slower by 60-basis points at 7.2 percent, and a modified stance “…to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”.
The message was reinforced at the post-policy conference by the RBI Governor specifically underlining the raised inflationary risks and rearrangement of policy priorities. The bond market responded breathtakingly with the 10-year (6.54 percent) benchmark yield jumping 19-basis points to 7.12 percent, increasing more since this week.
Markets and analysts hadn’t expected any action despite the RBI’s communication in preceding weeks about forecast revisions in the April review owing to developments associated with the Russia-Ukraine war; or the government’s steady and daily pass-on to retail-level the prices of all fuels. They were focused upon what the MPC would signal about the future policy course and its normalisation. In part this was because of the past assurance that changes would be ‘well-telegraphed’ in advance. Partly, this was because beliefs about the tolerance of a higher-for-longer inflation by a pro-growth RBI in an environment of fiscal dominance had crept in.
All that is now past. Supply or demand, good or bad inflation, it figures prominently in the policy trade-off. This has been well-telegraphed although many may argue the gear shift, sudden as it is and the heavy-duty impact it has had upon markets and the environment, was anything but. The strangely-worded stance – remaining accommodative while focusing on withdrawal of accommodation – indicates conditions will be less ultra-easy, as elaborated at the post-policy conference.
RBI Deputy Governor Michael Patra said that the movement towards a positive real policy rate has begun, although it’s presently unclear what this might be, and adding that for India’s stage of development, this needs to be positive. As to the distance to positive real rate territory, this is uncertain; at best, speculation with plenty depending upon the evolution of commodity prices.
The central bank made it clear — in forward guidance as it were — that it is ‘ready to take whatever action is required’ and will act ‘as per the emerging situation’, and ‘will be nimble’. Entirely in line with the enlarged uncertainties embedded in the fan charts of RBI’s latest inflation projections, this indicates monetary actions are bespoke than smooth or pre-guided adjustments. It also fits into the multiple challenges posed by an exceptionally uncertain environment with diverse risks: geopolitical, the US monetary tightening, and QT in place of QE (quantitative tightening instead of easing), slowing world demand and possible recession, domestic inflation and slowing growth, the pressure of large government borrowings, among some. It allows balancing of possibly competing policy demands or claims at any point of time in the forthcoming months ahead.
This is also buttressed by the RBI’s fortification of its toolkit — it has substituted the reverse repo rate (this remains unadjusted but, on the instruments menu) with an uncollateralised standing deposit facility (SDF) as the LAF floor; at 3.75 percent, this restores the corridor to 50-basis points, the pre-pandemic level, and is an operative increase of 40-basis points to remove overnight liquidity.
Since monetary actions are conditional upon the inflation readings, this obviously puts the spotlight on the incoming data. In particular, the impact of the fuel prices’ pass-throughs, direct and indirect, will be cumulatively visible in the present quarter’s CPI inflation, where the projected central tendency is currently 6.3 percent.
If exceeded, could a policy rate hike follow on its heels? Or would a changeover to ‘neutral’ stance come first? The RBI has communicated in advance that if inflation surprises on the upside, it will act. No surprise there.
Renu Kohli is a New Delhi-based macroeconomist. Views are personal, and do not represent the stand of this publication.
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