Five wise men and a wise woman — the Monetary Policy Committee (MPC) — will meet this week to decide on policy rates in Asia’s third-largest economy.
This is the fourth meeting of the Indian central bank’s new rate-setting body, which was reconstituted in October last year, and the first in fiscal year 2021-22.
Ahead of the meeting, the government announced its decision to keep the “flexible” inflation target of the monetary policy framework unchanged at 4 per cent with a two percentage points band on either side for the next five years, till 2025-26.
For the record, since April 2016, when the inflation targeting regime started, the Reserve Bank of India (RBI) had been on the ball till November 2019, barring two occasions –July 2017, when inflation had risen to 6.07 per cent; and June 2017, when it dipped to 1.46 per cent. In December 2019, inflation rose to 7.35 per cent and for the next one year, barring March 2020, it remained above 6 per cent till it dropped to 4.59 per cent in December 2020. It has since been within the target.
At the last MPC meeting in February, in line with expectation, the RBI had kept its policy rates unchanged and committed to continue with the accommodative stance as long as necessary – even in the current fiscal year that started last week. The decision was unanimous by all six MPC members.
Outlining the increasingly better outlook on growth, the RBI, in February, pegged the growth forecast for the new year at 10.5 per cent, closer to the latest projection of the World Bank, while highlighting the “cost push” risks on core inflation as consumer demand picks up. Last week, the World Bank raised projections for India’s economic growth by 4.7 percentage points to 10.1 per cent for 2021-22 on the back of the strong rebound in private consumption and investment growth. In January, it had pegged the GDP growth at 5.5 per cent.
What has changed in the past two months since the last policy was announced in February?
Revenue from the goods and services tax (GST) touched a record high in March, close to Rs1.24 trillion, staying over the Rs1.1 trillion-mark for four months a row. This is the highest GST collection since it was introduced in July 2017. In March, India’s merchandise exports also jumped 58 per cent year-on-year to touch $34 billion even as imports grew close to 53 per cent, over $48 billion.
While these data signal a recovery in demand and growing consumption, the combined output of eight core sectors contracted 4.6 per cent in February, snapping the pace of a nascent growth witnessed in the past two months. Clearly, we cannot expect a speedy recovery in industrial growth.
Looming large over these figures is a fresh wave of the Covid pandemic sweeping many Indian states. At this juncture, a status quo policy with a continuing accommodative stance, as long as required, could be the outcome of the MPC meeting. This is even as retail inflation rose to 5.03 per cent in February, higher than most analysts’ estimates, after falling for three consecutive months. Core inflation, excluding food, fuel and light, climbed to 5.59 per cent in February.
Riding on food, oil and prices of certain core items, retail inflation is expected to rise further after remaining within the mandated-band for three months in a row. The RBI’s inflation projection for the first half of the new fiscal year (April-September) is 5-5.2 per cent; it may need to revisit this.
To its credit, the central bank has managed a record Rs13.5 trillion government borrowing in 2020-21 rather well. The 10-year bond yield, which rose to 6.5 per cent in April 2020, cooled down and closed the financial year at close to 6.18 per cent, around 30 basis points higher than the December quarter. (One basis point is one-hundredth of a percentage point. Bond prices and yields move in opposite directions.)
The RBI used every weapon in its arsenal to see through the borrowing, keep the cost of money low for the government and lessen the banks’ pain of treasury losses -– twists (simultaneous purchase and sale of government securities); OMOs (open market operation); extending the limit of bond portfolio kept under the so-called held-to-maturity category; a series of devolvement of bond auctions on primary dealers; and even cancellation of an auction. The 10-year yield has averaged 5.96 per cent and, at the lowest end, the 91-day treasury bill fell below 3 per cent last year.
Indeed, it was no mean task for the central bank. Little over a decade back, in the financial year 2010, the gross borrowing was just one-third of this. It rose marginally in 2011 and ranged Rs5 trillion-Rs5.9 trillion in the next six years till 2017 before crossing Rs6.6 trillion in 2018. It dropped to Rs5.96 trillion again in 2019 before rising to Rs7 trillion in 2020.
In the current financial year, the government’s gross borrowing is pegged at Rs12 trillion – around 60 per cent of which, Rs7.24 trillion, will be raised in the first half of the year. Incidentally, the State of the Economy report in March, authored by deputy governor and MPC member Michael Patra, among others, has sought the cooperation of the bond buyers, saying: “The Reserve Bank is striving to ensure an orderly evolution of the yield curve, but it takes two to tango and forestall a tandav.”
When the bond supply is so large and inflation and expectations of inflation are rising, keeping away from a tandav is a tough task, particularly when the yield has been moving northwards in the US and other emerging markets.
Like other central banks, the RBI cannot afford to show any worry about inflation as it needs to support growth and the success of bond issuances. It is not likely to take away the punch bowl of massive liquidity and stimulus in a hurry. The bond dealers will be happy if there is an OMO calendar but a more potent weapon to manage the yield and push the applecart of growth will be a disinvestment/privatisation calendar by the government!
At this juncture, the three risk factors on the RBI radar are: A new wave of the Covid pandemic; rising inflation; and higher bond yields. The focus will remain on growth, and to ensure that, an accommodative monetary policy, as long as it is required. The RBI is unlikely to tinker with the policy repo rate this calendar year. If at all, we may see an increase in the reverse repo rate to streamline short-term interest rates. But even that is unlikely to happen soon.