Growth still not durable and inflation transitory, markets not convinced


After much waiting for the Reserve Bank of India’s (RBI’s) stand on interest rates and policy stance, it is now understood that there will be no change. The reason is simple. RBI, like other monetary authorities, have reiterated time and again that it will do everything to stabilize growth. And growth does not happen fast; and also, the path is not even. Improvement in purchasing manager’s index or goods and service taxes collections in one month may reverse the next month. Moreover, there are statistical base effects which may cloud one’s judgement.

Under these conditions, the policy must be read carefully for three reasons. These perspectives relate to growth, inflation and liquidity. Here too, the path is predictable as the direction is clear once growth is given precedence over inflation. Therefore, when the monetary policy committee treats inflation as being transitory, the question to be asked is how one can define inflation as being temporary or transient. In the last 15 months since the pandemic struck, consumer price index-based inflation has been above 6% in 10 months, 5-6% in two months and 4-5% in three months. Quite clearly, the view of inflation being transitory can be debated. RBI’s opinion is that inflation will still be 5.9%, 5.3% and 5.8% in the remaining three quarters, which shows that it is more permanently in the 5-6% range. Hence, interpretation of inflation is one of perception.

How about growth? Here, there is a bit of irony. Growth will be 9.5% (CARE Ratings believes it will be lower by 0.5-0.7%), and for the quarters, it would be on a declining slope of 21.4%, 7.3%, 6.3% and 6.1%. The irony comes from the fact that while growth actually picks up in the economy as the unlock becomes more wholesome with services also being allowed to function, numerically, the growth numbers will come down due to the base effect. Therefore, logically, these numbers may not matter much as they will not reflect the reality on the ground, which holds for most “real” variables this year where sharp dips last year will provide the buoyancy this time.

It would be interesting to try and interpret the permanency of the growth path based on the MPC discourse. The term used is “growth on durable basis” which is open to interpretation. The three engines are firing at different paces—consumption, investment and trade. That is the good part. If this is so, then growth is clearly on the right path and there should be less concern. In fact, if we add what the chief economic advisor had to say about growth being 11% this year, it looks like that growth is back for sure. The governor also said that until one is convinced on growth, inflation will not be looked at too seriously. But if the growth path is certain, there is reason for the MPC to look at inflation because we are living in a world of negative returns for savers. At some stage, this reality has to be accepted and the growth argument will no longer hold. Quite clearly, this question will pop up in the next policy when growth will be up and so will inflation. It would be useful for the market if the MPC could define the criteria for feeling assured that growth is back. We may have to start increasing rates just as the Fed has also been talking on these lines.

RBI has taken a neutral view on liquidity, with the caveat that any opening given to banks to park their funds does not tantamount to withdrawal of the stimulus. This is important because the V3R (variable rate reverse repo) scheme which offers banks a chance to deploy their surplus funds for a longer tenure is not mandatory but an option being provided. There is a chance for rollover of the surpluses which is useful for banks. To balance the same, RBI has also kept open the on-tap targeted long-term repo operations (TLTROs) and marginal standing facility (MSF) open till December. This may not really matter as there has not been any interest shown in the on-tap TLTRO scheme so far.

A broader question to be posed is that when there is surplus liquidity in the system, what exactly is the gameplan for banks when they sell their holdings of government paper under the G-sec acquisition programme (GSAP). This is pertinent because the funds that they get are not being lent but being put in the reverse repo window which offers 3.35%. Therefore, giving up on a coupon rate of around 5.5-6.5% through the GSAP for investment in reverse repo does not sound an optimal action unless they are in a state to start lending in a big way. For example, RBI announced the purchase of the 5.63% 2026 paper which has a yield of 5.76%. Giving this up for reinvesting in 3.35% is puzzling. But as said by the governor, the average amount deployed in the reverse repo has only been increasing to a high daily average of 8.5 trillion in August from an average of 5.7 trillion in June. Banks have clearly been losing out on at least 200 basis points on these excess deployment in the reverse repo auctions, which finally affects their profit and loss (P&L).

How have the markets reacted? The 10-year bond has seen an increase in yield from 6.20 to 6.24% which shows the continuation in scepticism which has been witnessed also in successive auctions on Friday when paper goes unsubscribed or devolves on the PDs. Interestingly, the auction of 6.10% 2031 paper was not subscribed. The market is still not convinced.

Madan Sabnavis is chief economist, CARE Ratings and author of Hits & Misses: The Indian Banking Story. Views are personal.

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