The Monetary Policy Committee (MPC) decided to keep policy repo rates and reverse repo rates unchanged at 4.00 percent and 3.35 percent respectively. The MPC also decided to continue with an accommodative stance for as long as necessary to revive and sustain growth on a durable basis. At the outset, it appears that MPC has maintained the 'status quo, but as one reads the statement in detail, the indications are clearly otherwise as reflected in the bond yields which were trading 5-10 bps higher post policy announcement.
The minutes of the earlier MPC in June 2021 had already reflected concerns on persistently high inflation readings and the fact that it was being overlooked primarily to combat the economic slowdown induced by Covid-19. The concern manifested itself in a dissenting vote in this MPC for maintaining the accommodative stance. However, the decision to keep rates unchanged was unanimous.
The MPC also outlined a sequentially increasing amount for the Variable Reverse Rate Repos from current Rs 2 lakh crore to Rs 4 lakh crore by September-end. The governor has reassured that this should not be read as reversal of the accommodative stance. However, reduction in liquidity is likely to result in overnight rates inching up slightly.
While high consumer price index (CPI) readings are still being considered transient and supply side driven, there is a clear concern on readings beyond the upper band 6 percent on RBI's inflation target. The MPC also did acknowledge that economic recovery is on expected lines. Thus, for the financial year 2021-22, while the GDP growth estimates were maintained at 9.50 percent, the inflation forecast was revised upwards from 5.1 percent to 5.7 percent, nearer to the upper tolerance band. It will be difficult for the central bank to justify its accommodative stance if the estimates were to be revised further upwards going ahead.
Markets have been concerned about the rising CPI for quite some time but the central bank was of an alternative opinion. This tussle was reflecting in the auction results on the 10-year benchmark instrument over the last few months. However, RBI did appear to relent a bit and acknowledge the concern on inflation as the 10-year benchmark was recently seen trading at 6.20 percent levels. Today's policy statement clearly acknowledged the market's concern on the rising CPI readings.
Covid-19 led economic slowdown had led RBI to take various measures to support economic growth and maintain an accommodative monetary policy in line with most central banks globally since March 2020. In today's policy, the central bank appears to be hinting, for the first time, that it is probably getting ready to relook at the environment of high liquidity and low rates which have been prevalent for almost a year and a half now.
There was a definite change in the tone of today's policy statement which, though subtle, was clearly indicative of things to come. The concern on growing CPI readings will continue to reflect on the benchmark going ahead - leading to heightened volatility on the longer end of the curve. Given the rate scenario, we believe that investors should allocate funds towards funds having a maturity of up to 3 years to prevent portfolio shocks from rising interest rate risks.