First Monetary Policy Statement for 2021-22: No change expected in RBI's accommodative stance

 After the estimated fall in GDP of 7.5% in the last financial year, the economy is expected to recover by 10.5% in the current financial year, 2021-22. Inflation is expected to be about 4% in Q3 OF 21-22.  For much of the last financial year, inflation , as measured by CPI, was outside the upper limit of 6% set for the MPC; however in the last 3 months the number has trended down to 5% (February 2021). 

There is still considerable uncertainty on the path of the economy in the next financial year - COVID-19 is very much lurking around and India is witnessing a huge surge in cases.  One big positive is the unprecedented monetary and fiscal policy stimulus being pursued in the USA, the world's largest economy.

RBI has run a highly accommodative monetary policy during the last financial year. Although RBI has not dropped the repo rate further after May last year, through arguably every measure possible it has flooded the money market with liquidity. As a result, effectively the actual repo rate has been well below the 4% it currently stands. One sign of this is the current level of the call money rate - the rate at which banks lend to each other. It currently stands at about 3.6%, mid-way between the repo rate and the reverse repo rate, but for most of the period from September of last year till recently this rate was even below the reverse repo rate of 3.35%.

The real interest rate  - as measured by the difference between the one-year treasury bill rate and CPI inflation - has been in negative territory during much of the last financial year.  This has been appropriate in my view given to the unprecedented demand and supply shock to the economy because of COVID-19. Till we see some clear evidence of the withdrawal of COVID-19, and sustained recovery in the economy in the current financial year, it is necessary to have negative real rates. With the one-year treasury bill rate at 3.9% and RBI's projected inflation for 2021-22 at 4% in  Q3, but higher than 5% in H1 OF 2021-22, the real rate should be negative somewhat for most of the current financial year. In this context, my blog of August 6, 2020 on monetary policy is relevant.

I expect no change in RBI's stance tomorrow when the MPC announces its decision, and the repo rate to be unchanged at 4%.