RBI monetary policy: Rates on hold amid uneasiness on inflation

Despite the unpresented stress and uncertainty in the economic outlook, the monetary policy committee (MPC) unanimously kept the policy rates unchanged in its August 2020 review, deferring to its primary mandate of ensuring that the Consumer Price Index (CPI) inflation remains within a band of 2-6 per cent.

This target was breached mildly in June 2020, while the MPC indicated it will treat the imputed data for the lockdown months of April-May 2020 as a break in the series. The committee highlighted that inflation risks emanate from supply chain disruptions, high vegetable prices, increased taxes on fuels, and volatility in financial markets. However, the ample rabi harvest and modest increase in minimum support prices lend some support to the case for benign inflation.

Overall, the statement revealed a distinct uneasiness on the underlying inflationary pressures, despite the forecast of a base-effect led moderation in second half of 2020-21 (FY21).

In terms of economic activity, the MPC averred that a recovery in the rural sector is underway, benefiting from the swift kharif sowing. Perhaps swayed by this, firms appear hopeful of a gradual improvement in domestic demand. However, consumer confidence as measured by a survey that the Reserve Bank of India conducts in urban areas, unexpectedly became more pessimistic in July 2020 relative to the May 2020 round. It is possible that the climbing Covid-19 infections outweighed the positivity generated by the unlocking of the economy. Moreover, with external demand likely to remain subdued, the MPC expects a contraction in real gross domestic product in FY21.

Accordingly, the committee stated that supporting an economic recovery assumes primacy in the conduct of monetary policy, and therefore, retained the stance as accommodative. Nevertheless, its emphasis that the space for future monetary policy action should be used judiciously and opportunistically suggests we are close to the end of the rate-easing cycle.

Accordingly, we expect only one more rate cut. Whether this materialises as early as the next scheduled policy review in October 2020 would be guided by the inflation prints for July-August 2020. Based on our forecast, the CPI inflation hardened in July 2020, led by the spike in vegetable prices, climbing fuel prices, and disruptions caused by the localised lockdowns.

Early data suggests that this uptick will reverse in the ongoing month. However, with lockdowns getting extended in several states, the August 2020 CPI print may not generate enough conviction that inflation is falling fast enough toward the MPC’s medium-term target of 4 per cent. Therefore, rate easing may not resume until December 2020.


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