In its December meeting, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) voted unanimously to maintain the status quo on interest rates. The decision, in line with expectations, was driven by retail inflation continuing to remain well above the MPC’s upper tolerance level. While space for further easing in the near-term is likely to be restricted given the likely trajectory of inflation, an extended pause implies that interest rates will remain low for a long period of time. Further, by continuing to maintain its accommodative stance and providing firm forward guidance — the MPC expects to maintain its current stance at least during the current financial year and into the next financial year — the committee has sent a clear signal of its intent to continue to attach primacy to growth considerations, serving well to boost sentiment.
The outlook on inflation continues to remain a matter of concern. The RBI now expects retail inflation to remain elevated at 6.8 per cent in the third quarter, trending down to 5.8 per cent in the fourth quarter, as against earlier predictions of inflation ranging between 4.5 and 5.4 per cent in the second half of the year. While this build-up in inflation is due to supply side disruptions, excessive margins and indirect taxes, core inflation has also edged upwards, providing evidence of spreading price pressures. The RBI now expects inflation to range from 4.6-5.2 per cent in the first half of next year. However, inflation may well firm up as demand picks up. This would lower any changes of further easing of policy rates. In the run-up to this meeting, given the excess liquidity in the system, and as a consequence the collapse in the short-term interest rates, there were expectations that the central bank would announce measures or provide some guidance on how it plans to suck out the excess liquidity from the system. However, the governor’s commentary seems to indicate that the excess liquidity will not be withdrawn hurriedly, as growth concern remains. This will have a calming effect on bond yields. Further, the decision to expand the on-tap targeted long-term repo operations to stressed sectors, in line with the government’s Emergency Credit Line Guarantee Scheme, signals intent to continue providing liquidity support to the economy.
On the growth front, with economic activities bouncing back stronger than expected, the RBI has revised its growth forecasts, pegging the contraction in GDP for the full year at 7.5 per cent, up from its October policy forecast of 9.5 per cent. Growth is now expected to turn mildly positive in the second half of the year. However, a sustained pick-up in economic activities will depend on continued policy support, especially higher government spending, which until now, despite the announcement of various relief packages, has not met expectations.
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