Retail inflation readings have surprised on the higher side after the June MPC meeting. However, the communication from the RBI has continued to be on “transitory” factors contributing to inflation, says YES .
Our model indicates a climb down of Headline CPI inflation to within the target band of 4+/-2 percent from the next reading and is likely to soften with a high base from last year. Moreover, global commodity prices are stabilizing now, implying that imported inflation fears could recede. Overall, even as economic conditions are recovering as we come out of the 2nd COVID wave, we see RBI to signal growth concerns and keep monetary policy rates and stance accommodative.
Policy makers face a mixed bag of growth data
Recently data releases such as July GST collections, volume of E-way bills, PMI manufacturing, core index suggest that the economy is stabilising with the easing of restrictions in most parts of the country. However, the RBI would continue to be cognizant of the differential speed of recovery of the various sectors of the economy and the divergence between the formal and the informal sector.
Note that Dr Mridul Saggar had highlighed risks for the informal sector in his comments in the MPC minutes: ”Initial GDP estimates do not provide full visibility and the impact on informal and unorganised economy may be deeper”. This concern is unlikely to have changed between the June policy and now. Furthermore, risks of a 3rd wave are already evident (despite recent studies putting the seropositivity rate at 67%) with “R (reproductive rate)” greater than 1.0 in 8 states while pace of vaccination have remained low (8 percent of population is fully vaccinated and 28.4 percent has received at least one dose). In such uncertain conditions, precautionary savings behaviour of households may continue (despite some improvement in consumer sentiment), implying muted consumption expenditure and limited investment demand of the private sector.
The RBI’s real GDP projection of 9.5 percent will be retained, having brought down by 100 bps in last meeting.
Argument of “transitory” hump for inflation will persist
RBI goes into this policy with both May and June Headline CPI prints breaching the 6.0 percent threshold. Even as core CPI may be relatively sticky, there are signs for the Headline print moderating. Our model predicts the next Headline reading at 5.4 percent and inflation is expected to slide even lower with the high base from last year. Overall, commodity prices appear to have stabilized now with Brent Crude trading in the $70-72/bbl on the back of emerging global growth concerns from the Delta variant. The demand effect on inflation is also not visible at the moment with M3 growth failing to follow the high reserve money growth and with velocity of money remaining low.
We think that the RBI will push up its inflation forecast by around 20bps for the year. However this is unlikely to impact its reaction function as the RBI will continue to point towards “transitory” reasons of supply constraints for inflation remaining firm.
Will RBI signal liquidity withdrawal?
Liquidity has moved into a significant positive zone. The net liquidity absorbed by the RBI amounts to Rs 7.5 trillion as on August 3 while the durable liquidity surplus in the system is close to Rs 10 trillion. Despite this, bond yields have tended to inch up recently – both for the 10-year and the 5-year G-sec. We think that the liquidity comfort will be essential for the markets for now and an attempt towards fine tuning will have to be carefully communicated to prevent any adverse impact on yields.
The current outstanding variable rate reverse repo (VRRR) matures on 13th August and the RBI will attempt to roll it over, possibly for a longer duration. This action may or may not be announced in the policy itself and can be announced closer to the maturity date of the VRRR. Overall, we do not expect the RBI to come out with any commentary aimed at tightening liquidity in this policy. Importantly, we think that if the RBI is able to ramp up its liquidity absorption via the VRRR tool, it can vacate space for a relatively enhanced G-SAP, that in the process will enable the RBI to better control yields.
A status quo policy, but MPC minutes will be interesting
Overall, we expect a status quo policy tomorrow. We also expect the RBI to remain patient with any policy maneuver till the end of FY22 and focus more on domestic conditions of evolving growth-inflation mix. However, the minutes of this meeting may provide interesting insights into the MPC’s mind and provide a guidance to the future trajectory of monetary policy, especially as growth appears to be at an inflection point but with inflation moderating.
(Indranil Pan is Chief Economist, YES Bank)