RBI’s new inflation path may slow policy normalisation, Nomura says

Informist, Friday, Sep 17, 2021


MUMBAI – The Reserve Bank of India's new 'inflation glide path' tolerating higher inflation for longer suggests risks of a delayed policy normalisation, which could increase the risk of monetary policy falling behind the curve, Nomura said in a report on Thursday.



In his recent speech at a Confederation of Indian Industry event, the RBI Deputy Governor Michael Patra emphasised that growth remains a priority for the central bank and downplayed the risk of elevated inflation, suggesting a gradual path to policy normalisation. He also suggested that RBI is looking at an 'inflation glide path' to achieve the medium-term inflation target of 4% by 2023-24 (Apr-Mar).


The deputy governor said on Thursday that the RBI's inflation glide path, which was first mentioned in the August monetary policy, would take CPI inflation print in 2021-22 (Apr-Mar) to 5.7%, and would bring it down below 5% in 2022-23 (Apr-Mar).


"We think (RBI) Deputy Governor (Michael) Patra's comments, together with (RBI) Governor (Shaktikanta) Das’ recent comments, send a clear signal that there is a strong institutional (RBI) consensus that it is too premature for policy normalisation, even as some external MPC members have voiced discomfort on low levels of reverse repo rate and excess liquidity," said Nomura in the research note.



According to Nomura, the RBI believes that the risk of inflation becoming persistent is low, whereas a premature normalisation could pose high risk and derail the growth recovery and thus tolerating slightly higher inflation instead of sacrificing growth remains an optimal choice for the central bank.



The RBI, in its August monetary policy had said that it was trying to set a glide path for inflation to bring it to the target.


The inflation glide path effectively seeks to dismantle the urgency of reverting to the 4% inflation target and the target rather seems to be a variable one. The tolerance for higher inflation for next two years would suggest that inflation has remained above the RBI's medium-term target of 4% for four consecutive years, Nomura said.


As the RBI seems to view liquidity as a tool to implement its monetary policy objective, it is not overly concerned as of now with adverse consequences of excess liquidity in the system, which is estimated to be around 9 trln rupees or 4% of GDP, Nomura said.


If the inflation glide path is indeed operational, the RBI could be comfortable with an extended period of liquidity surplus, although the quantum of surplus is unclear, Nomura said.


Nomura believes that their expectations of higher quantum of variable rate reverse repo and reduced size of RBI's government securities acquisition in October along with a reverse repo rate hike in December seem to be in contrast with the RBI's signal of continued patience. Nomura expects a 40-basis-point reverse repo rate hike in December and a cumulative hike of 75 bps in repo rate and reverse repo rate during 2022.


However, the Monetary Policy Review meet in October is likely to shed more light on whether the inflation glide path is shared more broadly by other rate-setting panel members, Nomura said. 


According to Nomura, the RBI's choice to remain behind the curve in order to focus on growth revival while tolerating higher inflation could prompt the risk of a faster catch-up next year if the medium-term inflation risk prove to be correct.  End



Reported by Nikhil Patwardhan

Edited by Akul Nishant Akhoury



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