Context

The Monetary Policy Committee of the RBI kept the benchmark policy rates unchanged, and retained the accommodative stance in its October review.

Factors playing part in monetary policy decisions

• It’s important to remember that monetary policy these days is influenced by both local macroeconomic developments and the global monetary policy direction, with the former playing a dominant role.
• Locally, after the second wave of the pandemic, a variety of indicators such as the Purchasing Managers Index (manufacturing and services), mobility indicators, government tax collections, exports and imports are pointing at an improvement in economic activity.
• Then there is the good news on the monsoon front. With a late pick-up in rains, the cumulative deficiency in this monsoon season has come down to just 1 per cent of the long-period average (LPA).
• Since the MPC’s August 2021 policy review, Covid-19 cases have trended down and there has been admirable progress on the vaccination front.
• Also, despite high year-on-year growth numbers, the level of economic activity this fiscal will only be 1.5 per cent above 2019-2020.

Trends emerging from the economic recovery

• Role of government: Capital expenditure of both the Centre and states is on track to meet the budgetary commitment, supported by healthy tax collections.
• Large companies on recovery path: Large companies in industrial sectors such as steel, cement, non-ferrous metals are operating at healthy utilisation levels, and have deleveraged their balance sheets.
• Policy support for smaller companies: The going is not so good for the smaller ones.
• Clearly, smaller companies need policy support. The extension of the Emergency Credit Line Guarantee Scheme is a recognition of that.
• Private consumption is not broad-based either.
• Even in goods consumption, which is faring better than services, the nature of demand seems skewed towards relatively higher-value items such as cars and utility vehicles.
• This probably reflects the income dichotomy spawned by the pandemic.
• Inflation: Its fall to 5.3 per cent in August offers only limited comfort for two reasons.
• One, core and fuel inflation, which have 54 per cent weightage in CPI, remain stubbornly high.
• Second, food prices have nudged down overall inflation.
• Domestic growth-inflation dynamics suggest that the RBI has little option but to remain more tolerant of persistent price pressures, and hope that these will eventually prove transitory because they have been primarily driven by supply shocks caused by the pandemic.

Global monetary policy environment

• Globally, the monetary policy environment is veering towards normalisation/tapering/interest-rate rise largely due to an upward surprise in inflation, or because some central banks feel the objectives of quantitative easing have been met.
• Central banks in advanced economies such as Norway, Korea and New Zealand have recently raised rates.
• The two systemically important central banks — the US Federal Reserve (Fed) and the European Central Bank (ECB) — view the current spike in inflation as fleeting and have communicated greater tolerance for it for a longer period.

Conclusion

The process of mopping up excess liquidity will slowly gain pace over the next few months, followed by a policy rate hike sometime around early 2022. By then, there should be enough clarity on the third wave and the stance of the Fed and the ECB.

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