Expect policy tightening only from September

Any change to a neutral stance or any hike in the policy rates has to wait a while because yields will spike at the first hint of tightening; remember, some Rs 7.24 lakh crore is to be mopped up by the Centre alone in H1FY22.

Given the damage caused to the economy by the second wave of the pandemic and high inflation, RBI’s challenges just got bigger. Last fiscal, the central bank was faced with several daunting tasks: supporting growth, reining in inflation, keeping bond yields in check, ensuring the rupee didn’t gain too much value and also pushing through the government’s gigantic borrowing programme. But, it came through with flying colours. This time around, there as many challenging goals, but environment is a lot less friendly. The impact of the second wave on the economy may be less severe, but consumer confidence is low; thousands of small units are struggling to survive and joblessness is very high. Also, while the Centre’s borrowing plan may be somewhat smaller (at Rs 12.05 lakh crore) than last year’s, it is nonetheless large.

Right now, RBI probably has no option but to bat for growth even as it agonises over inflation. It is possible growth expectations for the current year could be pared to a single-digit figure on Friday when the monetary policy statement is announced, even as concerns on inflation are highlighted. However, the tone is expected to remain dovish so as not to upset the bond markets. It will not be easy to ignore inflation risks, but an exit from the accommodative policy will need to wait at least till September, or even a little later depending on whether the pandemic throws us a third wave. Until then, the central bank will use every weapon in its armoury—and possibly even come up with new ones—as it works to keep liquidity adequate and interest rates low. Real credit growth is slowing and real interest rates may be negative but at this juncture, it is important industry—particularly, small businesses—get support. More critically, the government should be able to borrow at affordable rates so that it can spend to stimulate the economy as private-sector spending has been relatively muted.

Any change to a neutral stance or any hike in the policy rates has to wait a while because yields will spike at the first hint of tightening; remember, some Rs 7.24 lakh crore is to be mopped up by the Centre alone in H1FY22. Government cash balances may be relatively high right now, but one is not sure to what extent revenue collections will be hit over the course of the year; non-tax revenues are sure to fall short of the budgeted estimates. Indeed, RBI will need to continue to buy government bonds, to keep the bond markets happy. Apart from the OMOs, some economists have suggested it should announce another round of GSAP (government securities acquisition programme) possibly bigger than the Rs lakh crore for Q1FY22. They point out the process can easily be reversed if inflationary pressures build up too much and too soon.

As is known, inflationary pressures are building up globally. Input prices—of raw materials like crude oil derivatives—have been rising, adding to the costs of end-users. In India, manufacturers have been able to pass on some of this additional cost to end-consumers, but the remainder may be passed on later in the year, as and when demand picks up. Retail inflation moderated to 4.3% y-o-y in April largely due to favourable base effects, but there is a build-up in rural wages. Economists expect inflation to rise as we head into the festive season but remain well within 6% limit. What should help is the current account turning into deficit and a fall in the BoP; RBI would not need to buy as many dollars, and less liquidity would be infused, helping control inflation. In FY21, it did much of the heavy lifting but, from here on, the Centre needs to take over.