Shift from rates to managing the emerging Quadrilemma

The evolving and expected paths of growth recovery and inflation will inevitably lead to the MPC unanimously voting for a pause in the forthcoming review. Given the GDP prints for the first 2 quarters, we expect that the full FY21 growth to contract at around 7.5 per cent, with probability of a stronger recovery, based on the set of leading indicators which we track. 

Based on food and industrial metals price trends, CPI headline inflation, on the other hand, is likely to average 6.3 per cent in H2, significantly higher than RBI October forecast of 4.5-5.4 per cent. While the dynamics of this persistence due to supply chain led disruption is very different from the spirit of concerns in the Inflation Targeting framework, there are emerging risks and the optics are certain to prevent any policy repo rate reduction in the near future. The utility of any rate cuts — policy space permitting or otherwise — is moot. Revisions of RBI growth and inflation forecast will be closely watched. 

Given the constraints on a repo rate cut, the policy options for the MPC and RBI to manage and accelerate the recovery (which RBI has implemented since the onset of the pandemic with outstanding innovation and dyna­mism) is a complex set of alternatives involving economic and financial tradeoffs. Improving tax revenues for both the Centre and state Govts, which will gradually open up space for higher fiscal spends, is likely to be one positive. Communication and forward guidance on the accommodative stance to support growth for as long as necessary, will be crucial.

Given the comprehensive suite of incentives rolled out in the October policy, this review is likely to largely fine tune the measures, without similar bold additions. Credit has been one of the main pillars in the stimulus program. Bank credit growth (and offtake) has improved into early November, and is expected to sustain in H2. However, further micro-prudential relaxations and regulatory forbearance exten­sions are likely, to try and further cut banks’ risk aversion. 

Although the time for initiating normalisation is still distant, the MPC is likely to start discussing internally on the crucial balancing measures on complex trade-offs required to gradually tighten financial market conditions, without disrupting markets. This is the emerging policy “Quadrilemma”: the balancing of the complex trade-offs between the economic variables and the market ones. Liquidity management will be the core of this balancing. A large autonomous driver of liquidity has been RBI intervention in the foreign exchange markets. Given continuing loose global liquidity conditions, and India’s recovery, it is likely that capital inflows will continue apace, although some of this might be offset by increasing trade deficits. RBI OMOs will also add to this. Communication of an accommodative stance will largely be about liquidity. 

The author is executive vice-president, Business and Economic Research, Axis Bank.  Views are personal