Policy normalisation process has already kicked off

As expected MPC voted unanimously to leave the policy repo rate unchanged at 4%; but what was unexpected was the divided view (5 to 1 majority) in keeping the stance accommodative. In earlier minutes also, Prof Jayanth Varma expressed his reservations on maintaining the accommodative stance due to inflationary pressures. Reading the minutes of this MPC’s meeting would provide more insights into the MPC’s mind, their discussion around inflation and perhaps provide some guidance of future trajectory on policy normalisation. 
 

India’s economic activity picked up pace in June-July as some states eased pandemic containment measures. High-frequency indicators – e-way bills; toll collections; electricity generation; air traffic; railway freight traffic; port cargo; steel consumption, cement production; import of capital goods; passenger vehicle sales; two-wheeler sales – posted decent growth in June/July, reflecting adaptations to COVID related protocols and easing of containment. RBI kept its real GDP projection unchanged at 9.5% for FY22 (18.5% in Q1; 7.9% in Q2; 7.2% in Q3; and 6.6% in Q4 of 2021-22; 17.2% in Q1 of 2022-23).
 

Ramping up the vaccination drive and bridging the gaps in healthcare infrastructure and vital medical supplies can mitigate the pandemic’s devastation and improve consumer sentiments and lead to some durable growth in H2 of this fiscal.
 

On the inflation front, MPC continued with its view that the inflationary pressures during Q1FY22 are largely driven by adverse supply shocks which are expected to be transitory. Revival in south-west monsoon winds, pick-up in kharif sowing, moderation in CRB commodity index and Brent prices (after OPEC+ agreement) would help in easing the headline inflation. Input pressures (WPI) will work towards keeping core inflation elevated, while some food prices will reflect persisting demand-supply imbalances, but in the absence of strong demand, the pass-through to retail inflation is likely to be incomplete and delayed.
 

RBI noted that it has been closely monitoring the inflationary pressures and is conscious of its objective of anchoring inflation expectations. In light of the ongoing supply-side pressures; RBI revised its CPI inflation numbers for FY22 from 5.1% to 5.7% (vs the market expectation of 5.5%). MPC pointed out that more concerted steps are needed by the Government to ease supply constraints to restore the supply-demand imbalance.
 

10-yr Gsec yields inched up 4bps to 6.24% in reaction to the MPC outcome, reacting to higher inflation projection, divided view on stance and enhance VRRR (Variable rate reverse repo) auction amount. Although the Governor reiterated that these enhanced VRRR auctions should not be misread as a reversal of accommodative stance; market participants have decoded their own implication of the same. VRRR auctions would impact the short-end of the yield curve; while the long-end of the yield curve will remain anchored by the RBI through its G-SAP acquisition programme, OMOs and operation twists.
 

In terms of lending rates, there has been a gradual transmission of the policy rate cuts to bank lending rates as seen by a sharp fall in MCLR rates and in the weighted average lending rate (WALR) on fresh rupee loans. But credit cycle is yet to perk up, reflective of the lack of demand for bank funds by businesses and households alike who are averse to add to their liabilities amid economic and business uncertainties. While large industries have benefited from the pandemic and remain in deleveraging mode, MSMEs which have suffered disproportionately from the pandemic contributed to the lower offtake of bank credit. In such a scenario, a dovish policy may be required for the current nascent recovery to broaden.

In this uncertain environment, there exists a risk that the precautionary savings behaviour of households may continue (despite some improvement in consumer sentiment), implying muted consumption expenditure and limited investment demand of the private sector.
 

Overall RBI monetary policy was on expected lines and the policy statement highlighted its commitment to do whatever it takes to ensure financial stability and insulate domestic financial markets from global spillovers; while ensuring calibrated sustainable recovery and price stability. We feel the process of normalising seems to have begun in a small way as Gsec yields are allowed to move higher, divided view on stance and now the enhanced VRRR auction.

Deepak Jasani, head of retail research at HDFC Securities. Views are his own.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.