RBI Monetary Policy 2021 signals a shift towards policy normalization; change in stance in CY21 unlikely

August 06, 2021 5:06 PM

Markets ahead of the MPC policy were prepared for an uneventful one, with status quo across all parameters

rbiWhile we do not expect the MPC to change its stance in CY2021, the split in voting could further increase. Representative image. Reuters

By Upasna Bhardwaj

Markets ahead of the MPC policy were prepared for an uneventful one, with status quo across all parameters. While the MPC kept the policy rates and stance unchanged two surprises have unnerved the market. First, a split vote with Prof. Jayanth Varma dissenting against the accommodative stance. Notably, we had highlighted this as a reasonable risk for this policy but market consensus was for a unanimous decision. Second, given the risks to inflation the MPC has decided to take baby steps towards policy normalization. RBI increased the quantum of variable rate reverse repo (VRRR) to Rs 4tn from Rs 2tn currently, although in a phased manner until September 24, 2021.

While the upward revision to inflation was expected, the MPC has revised the inflation trajectory for FY2022 more sharply to 5.7% as against 5.1% projected in the June policy and our expectation of 5.5%. Meanwhile, on the growth front, MPC remains fairly optimistic, even though they retained their growth forecast at 9.5%.

We believe there is a subtle signaling of a shift towards policy normalization. The vote-split, the sharp upward revision of inflation and early liquidity normalization measures clearly indicate the growing nervousness around the ability to anchor inflationary expectations, even as the statement highlights the transitory nature of inflation. While the exact reason or nature of dissent by one member will be known in the minutes, the need for policy normalization is clearly being felt. Notably, the additional 14-day VRRR quantum is gradual and is expected to have limited impact on the overnight rates in the near term. However, this is the first step towards calibrating liquidity with tools like further increase in quantum of VRR, overnight VRR, and allowing non-bank participation in the VRRR could be announced as measures before the onset of policy normalization.

While we do not expect the MPC to change its stance in CY2021, the split in voting could further increase. We expect the hike in reverse repo rate to be around the December policy after risks of further Covid wave fade amidst higher pace of vaccination and visibility of durable growth. One point of note is that the MPC will continue to remain largely data dependant and any increasing risks to growth due to resurgence of covid cases could further postpone the normalization process. Today’s policy seals the case for the rates having bottomed out and hence we expect some realignment (especially on the shorter-end of the curve) in the months ahead. However, given the nature of the crisis and the related uncertainties we do not expect rates to escalate rapidly with the monetary policy normalisation expected to be very gradual.

(Upasna Bhardwaj is Senior Economist, Kotak Mahindra Bank. Views expressed are the author’s own.)

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