Inflation is moderating faster than foreseen, proves MPC's call right: RBI

The glide path should take inflation down to 5.7% in 2021-22; below 5% in 2022-23, and closer to 4% by 2023-24, said DG Patra

The Reserve Bank of India (RBI) on Thursday said the inflation trajectory is coming down faster than anticipated and the inflation print of 5.3 per cent in August has proven the monetary policy committee’s (MPC) move to look through May’s price shock as the right call.

The August consumer price index (CPI) inflation print came at 5.3 per cent, lower than what the RBI had predicted. The central bank had expected inflation at 5.9 per cent for the second quarter ended September, and 5.3 per cent for the third quarter ended December.

In the September bulletin, RBI has said the softening prices of various food items is likely to extend into Q3 which will, in effect, contain the upward pressure from fuel and core prices on headline inflation. “The task now is to consolidate these gains and carry them forward into Q4 as well”.

Speaking on similar lines, deputy governor, Michael Debabrata Patra, said data arrivals vindicate the MPC’s stance as inflation has moderated into the tolerance band, and growth in the first quarter is in almost perfect alignment with the RBI’s forecast. The RBI sees the economy is well and truly on track to achieve its projected growth rate of 9.5 per cent in the current financial year.

Now, the MPC will follow a glide path that will eventually bring down inflation in the economy closer to 4 per cent by 2023-24, which is the mandate given to the MPC. Given the pandemic situation, the MPC had to tolerate a higher average inflation rate of 6.2 per cent in 2020-21 but the glidepath envisaged by the committee should ensure that inflation will fall to 5.7 per cent in 2021-22 and below 5 per cent in 2022-23.

Speaking at a CII event, Patra said,“Taking into account the outlook on growth and inflation and keeping in mind the inherent output costs of disinflation, it is pragmatic to envisage a glide path along which the MPC can steer the path of inflation into the future”, Patra said.

As per MPC’s assessment, Patra said, inflationary pressures are largely driven by supply shocks and shocks are supposed to be transitory in nature. But, the repeated insistence of shocks is giving inflation a persistent character.

The deputy governor explained that only items constituting 20 per cent of the CPI are responsible for more than 50 per cent of inflation.

Patra also weighed in on the debate that has ensued wherein many commentators have said that the reverse repo rate has become the effective rate now, which, in a way, is undermining the MPC. Because under conditions of ample liquidity, the RBI has to switch to an absorption mode and the effective policy rate becomes the reverse repo rate.

Patra said the pandemic has called for out-of-the-box responses by the RBI, given that the credit channel of transmission broke down because of muted demand and risk aversion. Hence, the RBI decided to operate through other segments of the financial markets to keep the lifeblood of finance flowing. He further said at a time when the repo rate has been reduced by 250 basis points since February 2019 and there is hardly any room left to reduce it further given the inflation print, the reduction in reverse repo rate eased financial conditions so much that it facilitated record levels of access to finance by corporates and governments at low-interest rates/spreads.

But, when normalcy returns, they will resort to normal liquidity management operations and a regular and symmetric (liquidity adjustment facility) LAF corridor.

Interestingly, Jayanth R. Varma, the lone dissenting member of the MPC, had argued that the reverse repo rate does not fall within the remit of the MPC, then the announcement of this rate should be in the Governor’s statement and not in the MPC’s statement. Varma had voted in favour of a raise in the reverse repo rate, minutes of the August 4-6 meetings showed.

Assuaging market fears that with variable rate reverse repo (VRRR) auctions the RBI has, essentially, started the process of tightening, Patra said, the RBI will remain in surplus mode and the liquidity management framework will continue in absorption mode.

“..it (VRRRs) is not a signal either for withdrawal of liquidity or of lift-off of interest rates. Signals of the latter will be conveyed through the stance that is articulated by the MPC in its future resolutions. We don’t like tantrums; we like tepid and transparent transitions – glide paths rather than crash landings”, he said.

“It is our hope that credit demand will recover and banks will get back to their core function of financial intermediation as soon as they can. This is the natural and the RBI-preferred manner in which surpluses in the LAF can be reduced”, he said.

At the end of September up to which VRRRs auctions have been announced, the daily surplus absorbed under the LAF will still be around Rs 9 lakh crore – the same level as today – if not higher, more than half of which would still be under the fixed-rate reverse repo, Patra said.