The Reserve Bank of India (RBI) has managed to overcome the setback arising from the unprecedented postponement of its October 1, 2020 monetary policy review. The central bank will now announce its policy on October 9, now that the three new external members of the RBI’s six-member Monetary Policy Committee (MPC) have been named. The October 1 policy announcement could not be made owing to three vacancies in the MPC since there was no announcement at the time on who would fill those three slots.

The government has now announced that Jayanth R. Varma, Ashima Goyal, and Shashanka Bhide would be the new external members on the RBI’s MPC, which fixes key policy rates and the stance of the monetary policy. The new members come from different backgrounds, and this is expected to benefit the committee and help the RBI in coming to a reasoned conclusion. Varma, a professor at the Indian Institute of Management Ahmedabad, is no stranger to regulation, having been a whole-time director on the board of the Securities and Exchange Board of India (SEBI) back in the ’90s, at a time when SEBI was busy rolling out the structure of the modern capital market India has today. He is an expert on financial markets and their functioning. Goyal, on the other hand, has been a member of the RBI’s technical advisory committee and is a former member of the economic advisory council to the Prime Minister. Bhide, a senior advisor at the National Council for Applied Economic Research, brings with him a deep understanding of the rural economy and agricultural economics.

The financial markets will be keenly watching what stance the RBI’s policy statement takes when the three-day deliberations of the MPC, which began on October 7, conclude. RBI and its governor Shaktikanta Das have been at the forefront of activity to support the economy ever since the Coronavirus pandemic battered economic activity worldwide and in India. While the August policy statement decided to hold rates in the wake of the threat of rising inflation, Das has eased the benchmark repo rate by a substantial 115 basis points (bps) since February, in a bid to spur economic growth. Together with the rate actions, the RBI has also infused substantial liquidity by a host of other measures in order to ensure the virus-hit economy is not starved of funds. The central bank’s actions have come as welcome support to a government hamstrung by its inability to go beyond a point in providing stimulus to the economy, keeping fiscal deficit constraints in mind.

What, then, could the RBI do when it announces its next policy statement?

By all accounts, the popular vote in financial circles is in favour of yet another pause, given the rising inflation figures of late. In his August statement, governor Das had pointed to the fact that the MPC had seen inflation remaining elevated in the second quarter of 2020-21, but also added that this could ease by the second half of the fiscal, aided by base effects. At the end of its deliberations in August, the MPC had voted unanimously to leave the policy repo rate unchanged at 4% and to “continue with the accommodative stance of monetary policy as long as necessary to revive growth, mitigate the impact of Covid-19, while ensuring that inflation remains within the target going forward”.

A section of analysts sees inflation easing in the fourth quarter of 2020, in line with what the RBI has said, as lockdown restrictions are eased, economic activity resumes with some force, and the supply chain constraints are restored. Demand, however, is expected to still remain weak in general.

Despite the new faces on the MPC, few economists are betting on any radical change in the broad direction of policymaking. While some have called the new faces “dovish” on policy, Rahul Bajoria, chief economist at Barclays, in his October policy preview, says he does not see the RBI cutting any of the key rates for now. “Price trends since the last policy meeting have shown that headline CPI [consumer price index] has remained above the RBI’s target, and a ‘durable reduction’ has not manifested, which would allow the RBI to consider alternative policy options. On the other hand, there are some signs of improvement that activity is starting to return to normal as lockdown restrictions are eased. As such, India’s inflation-constrained central bank is unlikely to deliver a rate cut, and we expect all policy rates—the repo rate, the reverse repo rate, and the cash reserve ratio—to stay unchanged,” he says. However, he does expect the RBI to cut rates only once more, by 25 bps, in Q12021.

Importantly, economists, including Bajoria, are expecting the RBI to come up with its updated economic projections for the next six months. Bajoria reckons since the RBI Act requires the central bank to come up with economic projections every six months, the October policy statement may unveil some projections, however uncertain. That would give some signal to the financial markets about the RBI’s assessment of which way the economy is likely to move in the coming months.

In the absence of a rate cut option, governor Das will have to look at other avenues through which the RBI can support a deeply distressed economy. Bajoria makes a comparison with the RBI action during the global financial crisis of 2009-10, when the central bank slashed policy rates by as much as 425 bps, reduced the cash reserve ratio by 400 bps, and increased primary liquidity by an amount equal to 10% of GDP. Taken together, these measures resulted in a 15 percentage point increase in the M3 money supply to GDP ratio, which provided support for the subsequent recovery in economic growth. By contrast, during the current Coronavirus crisis, despite the RBI’s liquidity injection measures, the M3-GDP ratio has gone up by only nine percentage points, and hence there is room for more action on this front.

“To match the 2009-10 increase in reserve money, the RBI may have to continue its purchases of government bonds, which would help ease financial conditions and also support the government’s record borrowing programme in the second half of the current fiscal year. The central bank has taken an initial step by announcing an outright purchase of government bonds after a delay of six months, ” says Bajoria, adding that further purchases of government bonds are likely as the RBI steps up its support in the coming months.

It is likely that governor Das would have to rely more on liquidity and regulatory measures, rather than rate actions, till the RBI is comfortable with the inflation trajectory.

Meanwhile, some corporate leaders have already come on record to say that the worst could be over for the economy, given the improvement in some macroeconomic indicators. The growth in exports, the rising Manufacturing PMI (purchasing managers’ index), and the increasing car- and two-wheeler sales seem to have perked up sentiment in the corporate sector. The growth in the rural economy and green shoots in the consumer products and FMCG sectors are also factors which are contributing to optimism in some boardrooms.

For the RBI, however, the key task at hand will be to support these green shoots of growth further, while ensuring inflation is back in check. To that extent, the expertise of the three new MPC members couldn’t have come at a better time for Shaktikanta Das.

Ashima Goyal

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