RBI monetary policy review on Dec 4, rate cut prospects ‘remote’

The RBI’s Monetary Policy Committee (MPC) began its three-day meeting on Wednesday (December 3) amid expectations that the central bank will maintain status quo on the benchmark lending rates in view of high retail inflation. The RBI will announce its monetary policy review on Friday.

After its last MPC meeting in October, the central bank had kept its policy rates unchanged to help keep inflation – that surged past 6 per cent – in check.

The RBI has said the country’s GDP may contract by 9.5 per cent in the current fiscal due to the COVID-19 pandemic and has cut policy rates by 115 basis points since February.

Experts said that RBI may not slash policy rate in the wake of rising Consumer Price Index -based inflation driven mainly by supply side issues.

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Many are divided whether it is the right time for the central bank to absorb the surplus liquidity.

According to estimates quoted by Mint, the banking system currently has ₹5.31 trillion excess liquidity, thanks to the efforts by RBI to boost liquidity in a bid to revive the economy hit by COVID-19.

Amar Ambani, senior president and Institutional Research Head at Yes Securities, said frequency indicators and GDP data have conveyed a meaningful rebound in economic activity and retail inflation has remained stubbornly high. “We not only expect the RBI to maintain status quo in December 2020 policy meeting, but the minimal chance of a 25 bps rate cut in February 2021 also appears to be fading away”.

He expects the RBI to upgrade its growth outlook by scaling down its earlier projection of GDP (of 9.5 per cent) to an optimistic one.

Harihar Krishnamoorthy, treasurer at FirstRand, said the RBI should refrain from announcing any measures that may affect the excess liquidity that is helping the economy come back to normalcy.

“The current liquidity surplus has pushed retail savers to invest in cars and real estate. We will need many more months to ensure sustained recovery. The possibility of a rate cut is low at this point, and RBI hopefully should not announce any measures that will suck out the excess liquidity, which is helping the consumption revival,” he said.

Many, however, say that the RBI should announce measures to address the excess liquidity in the market.

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“With so much liquidity floating around, and bank credit still on the slow growth trajectory, as a matter of policy, RBI should be directing liquidity flow towards the long-end given the excessive fall in short-end yields. One way of achieving this is by advancing the CRR (cash reserve ratio) cut, which is expiring on March 27, which would lead to the draining of ₹1.46 trillion from the market. To balance that, RBI should announce a simultaneous open market operation of an equivalent amount,” Mint quoted Soumyakanti Ghosh, chief economist, State Bank of India as saying.

Other experts say that instead of entirely absorbing the excess liquidity, the RBI could fix the floor price on overnight rates that have fallen to record lows.

“The simplest solution is for RBI to introduce variable rate reverse repos (VRR) for a fixed quantum of say ₹4 trillion. By encouraging banks to bid closer to repo rate in this VRR, RBI can push up the weighted average remuneration to banks in the LAF (liquidity adjustment facility) window. This would then pull up rates in the call and tri-party repo markets,” said ICICI Securities in a recent note.

Brickwork Ratings (BWR) in a report said that given the continued contraction of the economy, MPC is likely to continue with its accommodative monetary policy stance to manage financial stability and support growth recovery.

“Considering the elevated inflation levels, BWR expects the RBI MPC to adopt a cautious approach and hold the repo rate at 4 per cent in its December meeting,” it said.

Retail inflation, calculated on the basis of CPI, continued to rise for the ninth month in a row in October, reaching 7.61 per cent on the back of high food prices. This is the highest level of retail inflation since May 2014 when the inflation was at 8.33 per cent.