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The minutes of the August meeting was of particular interest due to Professor Varma's 'dissent', the second in one year. “We expect VRRRs to be gradually increased further, either on tenor or amounts, to normalise liquidity skewness,” says Madhavi Arora, Lead Economist, Emkay Global Institutional Equities desk.
The August minutes of the Federal Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) of the met on August 4, 5 and 6 were more hawkish than the policy itself. The MPC determines the policy rate of interest required to realize the inflation target.
The dissenters, Professor Varma and Dr Saggar and Dr Goyal, made a case for the co-existence of (liquidity/policy) normalisation and an accommodative stance.
The other takeaway was that the expansion narrative was largely similar across the board, with members agreeing on the necessity for durable growth, though some split emerged on the persistence of inflation risks. We see FY22 inflation 30-35bps less than what the RBI had projected.
Do not see reverse repo rate hike
The October MPC may even see more active debate on definition/pace/mode of accommodation. We expect variable reverse repo rates (VRRRs) to be gradually increased further, either on tenor or amounts. We don't see a reverse repo rate hike this year and see the RBI maintaining its preference for curve flattening.
The dissenters argued for a more judicious forward guidance.
The minutes of the August meeting was of particular interest due to Professor Varma's 'dissent', the second in one year. The unease of Professor Varma arose from his assessment that:
(1) COVID is pervasive and yet impacting only a pocket of the economy. But a generic accommodative monetary policy can’t be targeted (unlike fiscal) and thus it's largely fuelling asset inflation. Forward guidance and monetary stance are getting counter-productive and can only increase inflation risk premium also as term premium.
(2) MPC's inflation target is 4 per cent, not 5 per cent, not 6 per cent. The tolerance band is to permit for estimation errors and using this flexibility overly will only cause inflation-targeting failures later (reminds us of Dr Patra’s narrative during former Governor Urjit Patel's days).
(3) Disagreement with the extent of the reverse repo rate, though it doesn't fall into the MPC’s purview. He argued that a much-needed phased normalisation of the corridor would increase the MPC’s ability to stay the repo rate at 4 per cent for a extended period.
Interestingly, the opposite silent noises seen within the June minutes made their way again. Dr Saggar, while emphasising the necessity for durable growth and policy accommodation, admitted that the danger of policy errors on either side remains, given the massive uncertainty on growth and inflation also as policy trade-offs.
He thus made a case for policy agility, should the necessity arise. He later involved the necessity to avoid inflation risks when credit demand improves – swiftly making a case for non-disruptive gradual unwinding “when the time comes” – lest making markets complacent of flush liquidity.
We even had the standard dove, Dr Goyal, using the word ‘normalisation’, whenever it starts – extending the argument that other (liquidity) normalisation can start even in an accommodative stance.
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The inflation transience continues but risks remain
The overall inflation and growth narrative was largely an equivalent because the August policy. But there have been mentions about the risks of inflation (and inflationary expectations) becoming more persistent from the so-called transient supply shocks and margin increases.
Case against higher administered fuel prices
The case against higher administered fuel prices was again stressed by a couple of members. whilst growth remains sub-par, Dr Patra noted that core inflation may stay sticky, given the COVID-related margin increases and tax hikes, even when some supply-side mismatches were easing.
The growth narrative was largely similar across the board, stressing on need for durability of recovery. Even the dissenter, Prof. Varma, agreed for a repo rate at 4 per cent on the rear of sub-par growth, albeit arguing (along with Prof Goyal) that policy accommodation and liquidity normalisation can co-exist.
Governor Shaktikanta Das, on the opposite hand, argued that the risk- reward still favours maintaining congenial financial conditions and monetary boosters.
Emerging differences may have implications for the October MPC.
While the predominant view remains the necessity to support recovery, the (dis)comfort with inflation dynamics is certainly dividing the MPC members.
The overall tone of the minutes is slightly more hawkish than the policy itself, but we still think state-based actions and guidance will lead the show within the end. We see inflation to be lower in FY22 (Emkay: 5.35 per cent; RBI: 5.7 per cent), which could give the RBI more room to manage expectations.
Interestingly, the core RBI MPC on net seems more convinced that normalising policy early would be an error – as was also seen within the recent bulletin authored by Dr Patra. It also argued the limited role of monetary policy to influence supply-driven inflation and therefore the more involved role of economic policy within the same.
The August minutes do little to vary our view that the improved VRRRs to mop up liquidity aren't to be seen as a reversal of policy stance but simply the normalization of liquidity skewness. We expect VRRRs to be gradually increased further, either on tenor or amounts, to normalize liquidity skewness. We don't see a reverse repo hike this civil year . We reckon the RBI will still strive to repair the artificially skewed yield curve and maintain its preference for curve flattening.