End in Sight of RBI’s Accommodative Stance

On the surface, Friday's Monetary Policy Committee (MPC) decision may appear to be another "status quo" policy. But, appearances may be deceiving, and they certainly are in this case. ON FRIDAY, the MPC's statement has significantly moved its attention to inflation control, relegating growth to a secondary goal. This trend has been influenced by the West's recent experiences with stubborn inflationary pressures, pricing pressures from the Russia-Ukraine war, and a shrinking domestic output gap. While this may appear to be a minor move in isolation, it represents the beginning of the end of monetary accommodation during the "pandemic age."

Given the recent surge in commodity prices, the MPC updated its CPI inflation predictions higher by 120 basis points to 5.7 percent but cut its FY2023 growth projections by 60 basis points to 7.2 percent. With the Standing Deposit Facility (SDF) implementation, the RBI revised the liquidity adjustment facility (LAF) corridor and restored the breadth of the new LAF corridor to pre-pandemic levels of 50 basis points. The SDF rate has been established at 3.75 percent, serving as the overnight rate floor, obviating the need for the fixed reverse repo rate. Meanwhile, the bond markets have been offered some comfort in a temporary increase in the held-to-maturity (HTM) limit to 23 percent. Still, no guarantee was made on the government securities acquisition plan (G-SAP) or open market operations (OMO) support.

In the recent past, the RBI promised markets that policy normalization would be well-telegraphed and non-disruptive. The RBI has taken a cautious approach to this trip, as it has promised. Unlike in other large countries, in India, inflationary pressures are still effectively managed, even though they threaten the MPC's top tolerance zone. As a result, the RBI may take its time and advocate for a gradual approach to combating inflation. Put another way; the RBI is in a fortunate situation since it is on time.

While the RBI has time on its side, it has little control over the majority of the factors that impact inflation. Because the bulk of the variables fueling our current domestic inflation is external. Unlike the RBI, most other central banks are falling behind in their fight against inflation. As a result, many people, including the US Federal Reserve, are rushing to tighten monetary conditions and even forgo growth to address this problem. While they will make their growth sacrifices in this process, whatever success they have in limiting inflationary pressures would aid the RBI's cause. RBI may profit from their accomplishment at almost no cost because they have the option of tightening at a steady pace. India may have accidentally outsourced some of its inflation management to desperate people to keep inflation under control. In some ways, it seems only fair that each economy's growth sacrifice is proportional to its inability to address the inflation problem promptly.

We anticipate the RBI's accommodating policy stance to shift to neutral in the near future. Following that, policy tightening will most likely be mild, with the magnitude decided by the growth-inflation dynamics at the time. In these times of heightened uncertainty, a cautious approach to normalization combined with a neutral policy stance will provide the RBI with the flexibility it requires.

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