RBI MPC Meeting: Here's why monetary policy normalisation will continue

The six member monetary policy committee ( MPC) is expected to keep the repo rate on hold at 4 per cent, while hinting that the monetary policy normalisation should continue because of several challenges. Here’s is why:

US Federal Reserve expects  to speed up withdrawal from easy liquidity

The US Central Bank has for long dismissed the inflationary pressure as being ‘transitory’ because of supply side shocks post Covid. The Fed chairman Jerome Powell has recently said that it is time now to retire the word ‘transitory.’ The reason being: there is no clarity on how long the supply side issues continue to impact inflation. The US retail inflation is already above the 2 per cent average targeted by the central bank. The gradual withdrawal of liquidity in the US markets and rise in interest rates in the near future would impact the fund flows into emerging markets like India. It could impact the rupee value against the dollar and give rise to the threat of imported inflation.

Interest rate hike globally on the back of higher inflation

The interest rate cycle has already turned northwards in many emerging economies because of inflation threat. The easy liquidity conditions and ultra low interest rates is a breeding ground for inflation. Emerging economies like  Russia , Brazil,  South Africa, Mexico, Poland,  Turkey , Columbia and few other countries have already hiked the interest rates. There are more hikes on the anvil.

The CPI or the retail inflation is on the rise in India because of higher commodity prices and crude oil

The RBI has projected a CPI of 5.3 per cent in 2021-22 which is likely to be breached in the coming months. In October , the CPI went up marginally to 4.48 per cent as compared to 4.35 per cent in September. The CPI had fallen from a high of 6.30 per cent in May 2021 to 4.35 per cent in September 2021. Prof. Jayanth R. Varma, one of the six MPC member, had said in the October meeting that the Covid-19 pandemic has mutated into a human tragedy rather than an economic crisis, and monetary policy is not the right instrument to deal with this. ”The ill effects of the pandemic are now concentrated in narrow pockets of the economy, and monetary policy is much less effective than fiscal policy for providing targeted relief to the worst affected segments of the economy. The inflationary pressures are beginning to show signs of greater persistence than anticipated earlier,” said Varma.

Controlling liquidity while keeping the accommodative stance

The RBI had kept the system at surplus liquidity which was around Rs 10 lakh crore plus before October this year. The average daily liquidity levels have reduced to Rs 8-9 lakh crore.  In the last few months, the RBI has been mopping up excess liquidity through auctions. Shanti Ekambaram, Group President – Consumer Banking, Kotak Mahindra Bank Ltd has said that with the economy on an upswing, led by a surge in consumer demand and ample liquidity, it was expected that the MPC would opt for gradual withdrawal of excess liquidity and a change in its accommodative stance in the December policy.

Narrowing  repo and reverse repo corridor

There are also expectations in the market that the RBI will narrow the corridor between repo (4 per cent ) and reverse repo rate ( 3.35 per cent). “ There is a high possibility of a reverse repo rate hike by 15-20 basis points in this policy. It should be followed by another reverse repo rate hike in February next year and repo rate hikes in the latter part of 2022,” says Pankaj Pathak, Fund Manager-Fixed Income, Quantum Mutual Fund.

“I am not in favour of the decision to keep the reverse repo rate at 3.35 per cent and vote against the accommodative stance,” dissented Varma on the monetary policy stance in October policy.

Also Read: RBI to hike reverse repo rate early next year: Reuters poll

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