The Reserve Bank of India (RBI) continued to keep the key lending rate unchanged at 4%, but seemed to embark on a path to normalise monetary policy by announcing the end of its government securities acquisition programme (G-SAP) as commodity prices inched up globally. The stimulus introduced due to the coronavirus pandemic may be gradually withdrawn over a period of time.

High commodity prices, particularly from China where India has $80 billion of imports, may be a risk to the domestic inflation. The RBI also announced bigger buybacks under the variable rate reverse repo (VRRR) auctions, signaling a tapering of its loose monetary policy. It announced further increase in liquidity absorption under VRRRs, from Rs 4 lakh crore at present to Rs 6 lakh crore by December 2021.

RBI Governor Shaktikanta Das said India’s crisis measures need to be in sync with macroeconomic development. But this syncing process will be "gradual, calibrated, and non-disruptive."

The programme, as per RBI's expectations, was successful in "anchoring the yield expectations" despite the government's large borrowing, Das said Friday. But now given the excess liquidity, "the need for undertaking further G-SAP operations does not arise."

RBI had injected Rs 2.37 lakh crore in the first six months of the current financial year via open market operations, including G-SAP. It had injected Rs 3.1 lakh crore during the full financial year 2020-21.

“Like many other central banks, the RBI is signalling a gradual move towards ‘normalising’ its monetary policy as the economy emerges from the shadow of the second wave. It is likely to first halt the unconventional easing measures it announced amid the pandemic. We expect this normalisation to continue in the coming months and a hike in the repo rate by 25 basis points by fiscal 2022-end, assuming strengthening economic recovery and elevated inflation risks,” rating agency Crisil said in a note.

The policy is also announced when the global energy market is currently in a conundrum. Natural gas and crude oil prices have jumped manifold in recent weeks. Subdued investment in fossil fuels will only imply that the resultant volatility could be a recurring theme in future. Interestingly, the world is currently witnessing a capital expenditure boom in container ships and microchips,” said Soumya Kanti Ghosh, chief economist at State Bank of India (SBI).

Additionally, the impact of rise of prices in China will have impact on general prices of all countries dependent on material inputs. India will be impacted from rising pricing in China. Under the assumption that there will be complete pass through of rise in cost, the rise in input cost for top 20 sectors dependent on China as per our estimates could be as much 2-6 basis points. Cumulatively, the impact could be 40-120 basis points. Against this background the RBI policy statement had to walk a very tightrope and delicate balance, Ghosh added in a report.

While the repo rate (key lending rate) remained unchanged at 4%, the RBI maintained status quo on the reverse repo at 3.35% (at which RBI borrows from banks) and marginal standing facility at 4.25%. The six member rate setting committee voted to maintain accommodative stance with a 5:1 majority, similar to the voting pattern in the August policy. 

Inflation to earn focus

The monetary policy committee (MPC) cut the projection for consumer price index (CPI) based inflation to 5.3% from 5.7% for this fiscal.

CPI inflation has fallen back within the RBI’s target of 2%-6%. It was on a downward trend from 6.3% year-on-year in June to 5.6% in July and 5.3% in August. This was driven by food inflation, which benefited from a high base, and a sequential decline in major items such as cereals and vegetables. 

The MPC expects food inflation to remain benign in the coming months, assuming  record-high kharif production keeps cereal prices soft; vegetable prices are contained by record production and government intervention; and supply-side measures help ease pressures on edible oils and pulses inflation. 

However, the MPC noted that non-food inflation remains elevated and excise duty cuts for petrol and diesel will lead to a more durable reduction in inflation and anchor inflation expectations.

Most economists agreed that high commodity prices on crude oil and oil are a risk on inflation. “Barring risks of a third Covid wave, we expect the focus to shift to inflation as the expectations remain elevated. Oil, policy normalisation, lack of GSAP and global factors should push up yields, overshadowing the fiscal positives,” DBS Research Group senior economist Radhika Rao said in a note.

Oil, policy normalisation, lack of GSAP and global factors should push up Gsec yields, overshadowing fiscal positives. 

“Expectations had started building in for the RBI to normalise the current surplus liquidity environment and guidance for any reversal in interest rate cycle. Any change in the interest rate cycle or expectation of it panning out in near term would have led to volatility in both equity and debt markets,” ICICI Securities said in a note.

 GDP forecast retained

The MPC retained the forecast for gross domestic product (GDP) growth at 9.5% for this fiscal. 

The pace of vaccinations and the approach of the festive season gave the committee hope for a rebound in the economy.

“A robust pace of vaccinations and controlled Covid-19 caseload should help release pent-up demand especially in urban areas for contact-based services. Normal monsoons and record high kharif production augur well for rural demand. Fiscal-monetary conditions are expected to remain supportive with pick-up in government capital expenditure and the RBI’s intent to maintain easy financial conditions. Strong external demand is expected to keep exports healthy. However, headwinds from high commodity prices, global financial market volatility and a possible third wave need to be monitored, Crisil said.

The continuance of the policy stance and no major disappointment soothed the capital market. While equity markets have taken the policy positively, debt markets reacted with some disappointment on discontinuance of GSec buying programme. The benchmark 10-year G-Sec yield moved up around 5 bps in an initial reaction to the RBI policy.