Endurance of accommodative stance into next fiscal fans hopes of back-ended rate cut: ICRA

A pause from the Monetary Policy Committee (MPC) in its October 2020 policy review was a foregone conclusion given the reiteration of the primacy of its inflation-targeting mandate during its last meeting.

Since then, the CPI inflation has not only remained well above the 6 percent threshold but has climbed further to 6.7 percent each in July-August 2020. Simultaneously, economic activity is slowly but surely crawling out of the abyss of Q1 FY2021.

In the October 2020 meeting, the fresh-look MPC, with three new external members, voted unanimously to maintain the Repo rate at 4.0 percent, and continue with the accommodative stance for as long as necessary to durably revive growth and mitigate the impact of COVID-19 on the Indian economy, whilst ensuring that inflation remains within the target of 2-6 percent going forward.

Interestingly, there was a second vote which was not unanimous; five of the six members voted to explicitly state that the accommodative stance would be continued at least during the current financial year, and into the next financial year.

After this glimpse of disunity, the minutes of today’s meeting will provide a deeper insight into the new MPC members’ individual views regarding the evolving growth-inflation outlook.

Looking ahead, the Committee highlighted that the weak pricing power of producers would persist, even as supply disruptions would ease after the lifting of localised lockdowns, helping to soften inflationary pressures. Moreover, healthy sowing of kharif crops and the fresh arrivals of vegetables would help to moderate prices. However, it cautioned that prices of pulses and oilseeds are likely to remain sticky, and domestic fuel prices may stay elevated in the absence of a roll back of tax hikes.

Overall, the MPC projected the CPI inflation to ease from 6.8 percent in Q2 FY2021 to 4.5-5.4 percent in H2 FY2021, with risks broadly balanced. Further, the CPI inflation for Q1 FY2022 was projected at a somewhat sticky 4.3 percent.

The MPC forecast a 9.5 percent contraction in the real GDP in FY2021, with downside risks, projecting de-growths of 9.8 percent and 5.6 percent, respectively, in Q2 FY2021 and Q3 FY2021, followed by a marginal 0.5 percent growth in Q4 FY2021. Further, the Committee pegged the pace of GDP growth at a sharp 20.6 percent in Q1 FY2022, albeit not fully offsetting the contraction of 23.9 percent witnessed in Q1 FY2021.

The policy statement struck a confident note on the outlook for economic activity, especially the projection of a mild growth in Q4 FY2021. However, we remain circumspect about generalising the green shoots that have spurted in the early data for September 2020, as they have benefitted from base effects and one-off shifts in some sectors, and may not sustain.

The timing of future Repo rate cuts has been rendered less relevant by the surfeit of liquidity enhancing measures announced by the Reserve Bank of India, and the expectation of continued support going forward. It remains to be seen if the commitment to facilitate state and central government borrowings, and the explicit signals aimed at softening yields, are able to offset the growing fiscal concerns and the large supply of state government bonds that is expected in Q4 FY2021.

Even as the inflation outlook suggests that the stage is set for an extended pause, the assurance that the accommodative stance will endure into the next fiscal year, will keep hopes of a back-ended rate cut alive.

(The author is Principal Economist at ICRA)