The MPC unanimously chose to keep all policy rates unchanged stating that “while space for further monetary policy action is available, it is important to use it judiciously to maximize the beneficial effects for underlying economic activity. At the same time, the MPC is conscious of its medium-term inflation target”. They also noted that “given the uncertainty surrounding the inflation outlook and extremely weak state of the economy in the midst of an unprecedented shock from the ongoing pandemic, the MPC decided to keep the policy rate on hold, while remaining watchful for a durable reduction in inflation to use available space to support the revival of the economy.”
In terms of estimates, the MPC continued to refrain from providing any estimates on GDP growth and inflation. It believes that inflation is likely to remain firm in 2QFY21 owing to supply-side risks and elevated domestic pump prices, but is likely to ease in 2HFY21 aided by favorable base effects. MPC acknowledged that 1HFY21 GDP growth along with the entire FY2021 GDP growth is likely to be negative. While an early containment of the pandemic may impart an upside to the outlook, a more protracted spread of the pandemic, deviations from the forecast of a normal monsoon and global financial market volatility are the key downside risks.
Overall, from the latest policy, clearly the MPC seems worried about the risk of supply-side shocks persisting for longer and hence the upside risks to inflation. Unless they see inflation peaking, there seems a limited scope for further easing. MPC also seems to be satisfied with their actions on rates until now. Inflation estimates suggest near term inflation closer to 6%, with 3QFY21 moderating significantly towards 3%. Since the inflation reading will be uncomfortably high till the October policy, the space for additional easing will open only towards the December policy, provided growth doesn’t improve.
The RBI MPC’s decision on keeping policy rates unchanged was not unexpected. The efficacy of rate cuts is anyway low in the current juncture. The tone of the policy was cautious with adequate concerns on the evolution of inflation trajectory while being fully supportive of growth prospects as and when inflation trajectory allows. We can expect the RBI to pause in the near term with the possibility of a rate cut from the December policy when inflation starts to fall. Going forward, liquidity measures will be important to watch for as the central and state governments borrow heavily under the revised borrowing plans.
Sudhakar Shanbhag is Chief Investment Officer, Kotak Mahindra Life Insurance Company Limited. Views expressed are the author’s personal.