SYNOPSIS
At some point of time, the RBI will have to tread the path of normalization.

As the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) met for its bi-monthly review last Friday, all stakeholders knew that signal interest rates would be left unchanged. What was of interest to the market participants was a finer point: whether the RBI MPC drops any hint on policy rate “normalization”.

In this context, normalization means moving from very low, ultra-supportive interest rates to a little higher but still low and supportive interest rates.

The reason is that while low interest rates are required to support the pandemic-hit economy, real interest rates are negative. This hurts savers and bank depositors, particularly senior citizens. On balance, given that economic recovery is nascent, the economy requires the support for some more time.

So, what did the six wise men/women, comprising the MPC, do on Friday? They reiterated the accommodative stance. To look at the language they spoke, “continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of covid-19 on the economy”.

The implication is that they continue to prioritize revival of the growth of the economy over inflation control, and that their stance is not going to change in a hurry.

To look at the details, what did they prognosticate about growth and inflation? The GDP (gross domestic product) growth projection for 2021-22 has been retained at 9.5%, as in the previous policy review on 4 June.

However, there is a change in the fine print. For Q1, that is, April-June 2021, growth is now projected higher at 21.4% against 18.5% projected on 4 June. This is coming on a low base of last year, and the impact of the second wave seems to be less severe than earlier. However, for the next three quarters, the growth forecast has been revised lower.

For Q2, that is, July-September 2021, it is now 7.3% from 7.9% earlier; for Q3, that is, October-December 2021, it is 6.3% from 7.2%, and for Q4, that is, January-March 2022, it is 6.1% from 6.6%.

Inflation projection is relevant to gauge the mindset of policymakers as it gives hints to what they may be thinking. The projected inflation for 2021-22 has now been revised upward to 5.7% from 5.1% as on 4 June. This upward revision was expected, given that there was a negative surprise in inflation in May and inflation for June also was on the higher side.

But the extent of upward revision is a little steep. While the market was expecting something around 5.5%, the projection has gone up to 5.7%. This is just a shout below 6%, which is the upper band of RBI’s tolerance zone.

Inflation for the first quarter i.e. April-June 2021, which was projected at 5.2% earlier, has surprised us at 5.6%, which is actual data available. For Q2, i.e. July-September 2021, inflation projection is now at 5.9% against 5.4% earlier; for Q3, it is at 5.3% now from 4.7%; and for Q4, it is 5.8% from 5.3%. However, as we discussed, the accommodative stance has been maintained in spite of the apprehensions on inflation.

What is expected going forward? At some point of time, the RBI will have to tread the path of normalization. The expected path is that the RBI would prepare the mindset of stakeholders to start with, gradually reduce the slush of surplus liquidity in the banking system and start with non-obtrusive rate hikes. There is a repo rate, currently at 4%, at which the RBI would lend money to banks when required and there is a reverse repo rate, currently at 3.35%, at which banks park surplus money with the RBI.

As of now, reverse repo, which is the lower band, is the effective rate. Gradually, as and when surplus liquidity is reduced, the effective rate would move towards repo. A reverse repo rate hike, keeping repo unchanged, would be a relatively non-obtrusive measure. Eventually, when required, there would be a repo rate hike, which is perceived as rate hike in the real sense.

While policymakers deliberate and act, what does it mean for you and me? For your equity investments, there is not much of incremental takeaway, only a small positive that the hand of support remains extended.

The bond market has reacted a little negatively, with the upward revision of inflation forecast being on the higher side of expectations; but that is only one of the many moving parts in the broader picture.

For people who avail of loans, do not expect things to become any better, and for depositors, do not expect any worse; it is a matter of time for the reversal signal from the referee.

Source: https://www.livemint.com/money/personal-finance/rbi-keeps-interest-rates-low-despite-economic-revival-11628615514999.html