Informist, Tuesday, Jun 6, 2023

By Pratiksha and Shubham Rana

MUMBAI/NEW DELHI - That the Reserve Bank of India's Monetary Policy Committee will keep the repo rate unchanged at its ongoing three-day policy review is now mostly a given. Market participants have, therefore, turned their attention to the policy stance, with the views split on what the rate-setting panel would decide to adopt on Thursday.

Considering that the macroeconomic situation has changed substantially since April 2022, when the "withdrawal of accommodation" stance was brought into the picture, analysts think it is time now for the MPC to change the stance or at least tweak the phrasing to reflect the new reality.

After raising the repo rate by a cumulative 250 basis points since May 2022, the committee unanimously decided to keep it unchanged at 6.50% in April.

As monetary policy transmission works with a lag, the full impact of this 250 bps of cumulative rate hike is yet to be seen. Inflation has moderated substantially, falling to an 18-month low of 4.7% in April from an eight-year high of 7.79% in April last year. Growth has also improved with GDP expanding by higher-than-expected 6.1% in the quarter ended March.

Though there have been calls for a change in the policy stance for some time, they have never been this loud.

The MPC did tweak the wording of the policy stance slightly in April to 'focus on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth' from the earlier 'focus on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth'. But the stance still remains withdrawal of accommodation, which has been a point of contention among the MPC members for a while now.

MPC external member Jayanth Varma, who has been expressing his reservations about the policy stance for some time, was more direct in April. "But I am unable to reconcile the language of the stance with the simple fact that no further "withdrawal of accommodation" remains to be done since the repo rate has already been raised to the 6.50% level prevailing at the beginning of the previous easing cycle in February 2019," he said in his minutes.

In an interview to Informist in May, HDFC Bank Chief Economist Abheek Barua echoed a similar view, saying he doesn't understand what the current policy stance means.

At a time when most market participants expect the repo rate to be left unchanged at 6.50% for the rest of the current financial year, keeping the current stance will only confuse the market, analysts said.

One interpretation that has been offered for the current stance is with respect to the real rates. That real rates--the rate of return over and above the expected rate of inflation--are not as high as they were when the stance was last neutral in early 2019. The last time the stance was neutral was in May 2019, the real rate was over 300 bps.  

"Currently, assuming headline CPI inflation will average 4.5-4.6% in Apr-Jun, real rates will be close to 200 bps with repo rate at 6.50%," Kaushik Das, chief economist, India & South Asia, Deutsche Bank, said in a report last week.

This makes the case for changing the stance to "neutral" even stronger.

A change that would signal the definite end to the rate hike cycle even if the RBI officials abstain from stating that on Thursday. But probably, the MPC doesn't want to signal that future rate hikes are ruled out, because of monsoon-related concerns, as another external MPC member Ashima Goyal told Informist in April.

"While pausing it was important, because of weather and oil price-related uncertainties, to give a stronger signal that the pause did not rule out future rate hikes, if required," Goyal had said.

The rate-setting panel may also not want to hint at the definite end of rate hikes with a stance change on fear that the markets may start pricing in interest rate cuts and disrupt the monetary policy transmission with lower borrowing costs. This worry also likely made RBI Governor Shaktikanta Das to state that the pause in the April meeting was just a pause and not a pivot.

With the MPC seen reluctant to signal that future rate hikes are ruled out, economists have suggested tweaking the stance instead of changing it to neutral.

"We think the time has come to dispense with the current stance and mint a new stance," ICICI Securities Primary Dealership said in a report last week. "Our preference will be for the MPC to change stance to something like 'neutral with a tightening bias' if only to retain the optionality to hike should external conditions and monsoon risks threaten the inflation picture."

The current liquidity scenario has also complicated the stance. While the stance indicates focus on withdrawing liquidity, in reality liquidity is being added to the banking system as a result of the withdrawal of the 2,000-rupee banknote and the central bank's foreign exchange operations. This certainly requires the central bank to rethink the wording of the stance, if not change it completely.

Monetary policy outcomes have not been short of talking points in the recent past, and Thursday is not expected to be any different because of the stance even when the repo rate is seen kept unchanged. 

While the committee may decide to stick to the current stance for a while longer, one sure shot possibility is that the stance won't be chosen unanimously. And if it is chosen unanimously, then that would just lead to more talking points.  End

Edited by Vandana Hingorani

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