Inflation finally in target range, but RBI may still not cut rates: Experts

Bond market is not factoring in a rate cut in February policy either

The December inflation print coming within the RBI’s target range of 2-6 per cent may have given some comfort to the six-member Monetary Policy Committee (MPC), but it may not immediately open the door to rate cuts, say experts.  

The consumer price index (CPI)-based inflation rate eased to a 15-month low of 4.59 per cent in December owing to a slump in food prices, and the base effect, but the core inflation remained largely sticky at 5.2 per cent from 5.4 per cent earlier. At the same time, the November Index of Industrial Production (IIP) contracted 1.9 per cent, against 4.2 per cent rise in October.

Nevertheless, the CPI inflation print “should comfort the MPC which will likely cut fourth-quarter inflation forecast meaningfully by 70-80 basis points amid current food price momentum”, wrote Emkay economist Madhavi Arora in a report.

This should help reinforce an accommodative stance throughout calendar 2021, but the MPC’s stand on policy rates and liquidity may not change or diverge soon, according to Emkay.  

“Liquidity normalisation is going to be slow and calibrated, ensuring that it does not become counter-productive amid sluggish growth and lead to premature tighter financial conditions,” Arora wrote.

The bond market, too, is not factoring in a rate cut in the February policy. Rather, it is carefully observing the RBI’s withdrawal from an ultra-loose liquidity environment.

The 10-year bond yield rose just two basis points to close at 5.95 per cent on Wednesday. But the short-term bond yields have risen in the week after the RBI said on Friday that it would resume variable reverse repo auctions, and would slowly go back to the normal routine of liquidity adjustment facilities.

“The circular has led the markets to start pricing in the sequence of steps for the withdrawal of the current monetary accommodation, starting with a reduction in the liquidity in the system,” said a fixed income fund manager with a mutual fund.  

“The fall in the inflation rate, though exceeding expectations, was somewhat priced in at the beginning of the month. So, the impact was quite limited.”

Soumya Kanti Ghosh, group chief economic advisor of the State Bank of India (SBI) group, said the inflation forecast for FY21 would now get re-rated towards an average of 6 per cent, while in fiscal 2021-22, inflation would stay around 4.5 per cent.  

“The RBI will likely remain accommodating, without any rate cut as long as growth remains nascent,” Ghosh said. 

Bank of Baroda’s chief economist Sameer Narang said while the central bank’s stance will likely remain accommodative into the next financial year, the extent of liquidity surplus may not be the same.  

“In addition, the RBI has started its normal liquidity operations because of which short-term yields will inch up from the lows seen in the last few months,” Narang said.  

The normalisation of liquidity operations is not a withdrawal, pointed out Ghosh. Rather, it is a redistribution of liquidity from less the than three months’ segment to medium term or more. Around Rs 3 trillion of liquidity is stuck in the short-term segment, estimated Ghosh, which the RBI may have wanted to direct towards the longer tenure securities.