RBI’s monetary policy review shows clarity of thought

It’s never an easy job to be handed control of price stability when inflation is repeatedly running amok. Yet, the RBI’s Monetary Policy Committee (MPC), with new external appointees, stood out on Friday. Inflation and interest rates are inversely correlated, which means when prices rise, policy rates need to go up. But for the first time, the MPC was explicit about its accommodative policy stance.

In its assessment, the current inflation hump is due to supply shocks, which it was willing to look through. Hence, the MPC gave time-bound guidance to remain accommodative ‘during the current financial year and into the next financial year’, setting aside the often-used ‘as long as necessary to revive growth on a durable basis’ for purposeful ambiguity. Effectively, rate hikes are out of the window and such clarity of thought is much needed because inflation may remain elevated for some more time. 

Unarguably, Friday’s review was Governor Shaktikanta Das’s finest so far under the extraordinary circumstances. Of late, bond markets are nothing but a mass of nerves due to supply glut on account of Central and state government securities aggregating Rs 22 lakh crore.

Their waning appetite was evident with three devolutions in the 10-year bond auctions last month. This perhaps prompted Das to launch a friendly joust that the RBI and bond market actions can be ‘competitive without being combative’. For brevity, he announced Rs 1 lakh crore on-tap targeted long-term repo operations and introduced open market operations for state government loans as a special case till March 31. This, along with the MPC’s accommodative stance, should temper bond yields.

Traders wasted no time to voice their approval, with 10-year and 3-year bond yields falling 8 and 16 bps respectively during intra-day trading on Friday. On growth, the RBI projects real GDP to contract 9.5% in FY21. While real-time indicators suggest economic activity may bottom out in Q3, Das said the near-term outlook remains hostage to the virus and given private investment may take longer to stabilise, only higher public capital spending will be the gamechanger.