money market: the RBI could remain accommodative for a while but will act on liquidity, according to the bond market

NEW DELHI: The Reserve Bank of India will detail its next monetary policy statement in just three weeks, and barring unforeseen national and global events, the central bank has received most of the major data sets that could influence its rate decision.

Data on India’s GDP growth in April-June and the latest data on India’s consumer and wholesale price inflation and industrial production have all been released. The data paint a fairly straightforward picture.

GDP growth in April-June, while recording a record high of 20.1%, fell short of market and analyst expectations, strongly boosted by a favorable statistical base effect.

While Indian industrial production saw a stronger than expected increase of 11.5% (year-on-year) in July, a closer look at the data shows that the recovery has been patchy, with analysts saying the manufacturing sector is still faced with headwinds.

Cut off from inflation. Headline retail sales inflation, which is the anchor of the RBI’s monetary policy, fell to 5.30% according to August data released earlier this week. The August CPI inflation reading was well below estimates by analysts who put the price gauge at around 5.60% for the month.

With the July CPI of 5.59% bringing average headline inflation to 5.44% so far in July-September, it seems clear that the RBI’s own estimate of 5.9% for the current quarter. course will be lower.

So far, the findings seem pretty clear – inflation is easing from highs seen earlier this year while growth still needs help recovering from the blows of the COVID-19 crisis.

The clear conclusion is that the central bank will continue to accommodate its policy and on this point there seems to be no doubt.

What is telling, however, is the market reaction to the lower than expected CPI inflation figure for August.

Normally, such a favorable development in inflation would have been seen as a harbinger of greater monetary generosity, but the markets did not seem happy.

Equity markets barely reacted, while the sovereign debt market – which is generally very sensitive to inflation numbers, has not budged either.

Bankers and Treasury officials who spoke to have pointed out a few reasons.

First, central bank officials, including RBI Governor Shaktikanta Das, have spoken at length in recent weeks in meetings (public and private) about the need to support growth, but also said that the process of normalization of monetary policy is on the cards.

While the central bank has made it clear that it will communicate its movements very clearly to the markets, the takeaway is that normalization is undoubtedly being discussed on Mint Street and that when it comes to interest rates , there is only one direction in which they are likely to move – north.

“We are fully aware and will not try to make any changes that would surprise the market … as I said earlier and would like to repeat – all of our actions will be calibrated, they will be timely, they will be careful and they will keep in mind aspects like what you mention. We don’t want to give any sudden shock or sudden surprise to the markets, “Das said in a recent interview.

There is no doubt that the passage of the crisis response that the central bank has adopted in response to COVID will take time, but what has happened with the recent wave of interactions with the central bank is that all the good news has been incorporated.

On the contrary, the debt market has now made peace with the inevitability of the central bank towards normalization.

While the benchmark policy rate is unlikely to be lifted until the next calendar year, what will certainly be addressed is the huge excess liquidity in the banking system.

The traditional channel of bank credit is certainly not a threat to inflation right now, but there are other ways in which excess liquidity is problematic, the most obvious being price bubbles. actives.

Sectors such as real estate have benefited greatly from the low cost of borrowing brought about by the huge excess liquidity and although this is a welcome thing for both the economy and homebuyers amid the COVID crisis. , there is a risk that high asset prices will fuel inflation. expectations.

Also, headline retail inflation may show a decline, but core inflation, which eliminates volatile components from food and fuel, remains sticky and high, with the latest reading standing at 5. 8%.

The central bank has already shown its willingness to bring excess liquidity under control by unexpectedly announcing a seven-day floating rate repurchase transaction. In its latest policy statement, the RBI announced phased increases in the amount of funds to be written through floating rate reverse repurchase agreements.

“The reason the markets didn’t react to the CPI is because the good news has been incorporated,” said a senior treasury official at a foreign bank.

“Yes, the RBI will be accommodating for a while, but will the repo rate go down? No. And on liquidity, it is certain that they will be very attentive to the quantity infused by OMOs. The market opinion is that the next cycle of GSAP will certainly be less than Rs 1 lakh crore. The unexpected 7-day reverse repo is a sign that the RBI is monitoring liquidity very closely, ”he said.

Some Treasury officials expect that in the next policy statement in October, the RBI will clearly signal its intention to increase the reverse repo rate and perhaps give a roadmap for the same.

“They (the RBI) said they would be very transparent. They may announce small rounds of repo rate increases with a timeline, ”the foreign bank’s treasury official said.

Earlier this week, RBI Deputy Governor Michael Patra said the central bank was considering a downward path to return to the 4% target for CPI inflation.

Growth should undoubtedly be the top priority right now, but at a time when major economies are showing signs of tightening monetary policy, the RBI shouldn’t get stuck if the inflation results were to hold back. bad surprises.

“… Greater political tolerance for inflation over a longer period suggests risks of delay in our view of policy normalization, but also implies an increasing risk of delay in monetary policy,” the economists wrote. by Nomura.

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