Growth still not sustainable and transitory inflation, markets not convinced


After much anticipation of the Reserve Bank of India’s (RBI) position on interest rates and policy, it is now understood that there will be no change. The reason is simple. The RBI, like other monetary authorities, has said time and again that it will do anything to stabilize growth. And growth doesn’t happen quickly; and also, the path is not equal. The improvement in the purchasing managers index or in the collection of taxes on goods and services over the course of one month could be reversed the following month. Additionally, there are some basic statistical effects that can cloud judgment.

Under these conditions, the font should be read carefully for three reasons. These outlooks focus on growth, inflation and liquidity. Again, the trajectory is predictable as the direction is clear once growth takes precedence over inflation. So when the monetary policy committee views inflation as transitory, the question arises how to define inflation as temporary or transitory. In the last 15 months since the start of the pandemic, inflation based on the Consumer Price Index has been above 6% in 10 months, 5-6% in two months and 4-5% in three month. Obviously, the idea of ​​transitory inflation can be debated. RBI’s view is that inflation will still be 5.9%, 5.3% and 5.8% in the remaining three quarters, showing that it is more sustainably in the 5-6% range. Therefore, the interpretation of inflation is a matter of perception.

What about growth? Here there is a bit of irony. Growth will be 9.5% (CARE Ratings estimates it will be 0.5-0.7% lower) and for quarters it would be on a downward slope of 21.4%, 7.3%, 6 , 3% and 6.1%. The irony comes from the fact that while growth accelerates in the economy as unlocking becomes healthier, with services also allowed to operate, numerically the growth numbers will decrease due to the effect. basic. Therefore, logically, these numbers may not matter much as they will not reflect the reality on the ground, which is true for most of the “real” variables this year, where the sharp declines of last year will provide buoyancy this time around.

It would be interesting to try to interpret the permanence of the growth path from the discourse of the MPC. The term used is “growth on a sustainable basis”, which is open to interpretation. The three engines operate at different rates: consumption, investment and trade. This is the good part. If so, then growth is clearly on the right track and there should be less worry. In fact, if we add what the Chief Economic Advisor had to say about 11% growth this year, it looks like growth is back for sure. The governor also said that until we are convinced of growth, inflation will not be taken too seriously. But if the path to growth is certain, there are reasons for the MPC to look at inflation because we live in a world of negative returns for savers. At some point, this reality has to be accepted and the growth argument will no longer hold up. Clearly enough, this question will arise in the next policy when growth is up and so is inflation. It would be helpful for the market if the MPC could set the criteria to feel confident that growth is back. We may need to start raising rates just as the Fed has also spoken on these lines.

The RBI has taken a neutral stance on liquidity, with the caveat that any openness given to banks to park their funds does not amount to a withdrawal of the stimulus. This is important because the V3R (Variable Rate Reverse Repo) scheme which offers banks the option of deploying their excess funds for a longer period is not mandatory but an option is provided. There is a possibility of carrying over surpluses, which is useful for banks. To balance the same, RBI also kept the Targeted Long-Term Repo Operations (TLTRO) and Permanent Marginal Facility (MSF) open until December. It might not really matter because so far there has been no interest in the TLTRO à la carte program.

A larger question to ask is: When there is excess liquidity in the system, what exactly is the game plan for banks when they sell their holdings of government securities as part of the acquisition program? G-sec (GSAP). This is relevant because the funds they get are not loaned out but placed in the reverse repurchase window which offers 3.35%. Therefore, forgoing a coupon rate of around 5.5-6.5% through the GSAP to invest in reverse repurchases does not seem like an optimal action unless they are able to start lending. importantly. For example, RBI announced the purchase of 5.63% 2026 paper which has a yield of 5.76%. Giving up that to reinvest in 3.35% is confusing. But as the governor said, the average amount deployed in reverse repurchase has only increased to reach a high daily average of 8,500 billion in August on an average of 5.7 trillion in June. Banks have clearly been losing by at least 200 basis points on these excess rollouts in reverse auctions, which ultimately affects their bottom line (P&L).

How did the markets react? The 10-year bond saw its yield increase from 6.20% to 6.24%, showing the persistence of skepticism that was also observed during successive Friday auctions when the paper is no longer subscribed to or vested in. PD. Interestingly, the 6.10% 2031 paper auction was not taken out. The market is still not convinced.

Madan Sabnavis is Chief Economist, CARE Ratings and author of Hits & Misses: Indian banking history. Opinions are personal.

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