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Budding dissents

* The Aug’21 minutes were more hawkish than the policy itself, with dissenter Prof. Jayanth Varma, Dr. Mridul Saggar and Dr. Ashima Goyal arguing that (liquidity/policy) normalization and accommodation can co-exist.

* The growth narrative was largely similar across, with members agreeing on the need for durable growth, but some splits emerged on persistent inflation risks. We estimate FY22 inflation to be 30- 35bps lower than the RBI forecast.

* The Oct’21 MPC meeting may see a more active debate on the definition/pace/mode of accommodation. In terms of VRRRs, we expect the RBI to either increase the amount or extend the tenor, but it will be simply reckoned as the normalization of liquidity skewness. We do not see a hike in the reverse repo rate this year and expect the RBI to maintain its preference for curve flattening.

The dissenter argues for more judicious forward guidance

The minutes of the Aug’21 MPC meeting were of particular interest this time because of Prof. Varma’s “dissent” for the second time in one year. Prof. Varma’s unease arose from his assessment that:

1) Covid is pervasive and yet impacts only a pocket of the economy. But a generic accommodative monetary policy cannot be targeted (unlike fiscal), as it is largely fueling asset inflation. The forward guidance and the monetary stance are becoming counterproductive and will only increase the inflation risk premium as well as the term premium.

2) The MPC’s inflation target is 4%, not 5% or 6%. The tolerance band is to allow for estimation errors and using this flexibility overly will only lead to inflation targeting failures later (reminded us of Dr. Michael Patra’s narrative during former Governor Urjit Patel’s days).

3) Disagreement over the level of the reverse repo rate even as it does not fall under the MPC’s purview − He argued that a much-needed phased normalization of the corridor would increase the MPC’s ability to keep the repo rate at 4% for a longer period.

Interestingly, the other silent noises seen in the Jun’21 minutes made their way again. Dr. Saggar, while emphasizing the need for durable growth and policy accommodation, admitted that the risk of policy errors on either side remains, given the large uncertainty around growth and inflation as well as policy trade-offs. He, thus, made a case for policy agility, should the need arise. He later called for the need to avoid inflation risks when credit demand improves – swiftly making a case for a non-disruptive gradual unwinding “when the time comes” – lest it would markets complacent about flush liquidity. We even saw the usual dove Dr. Goyal use the word “normalization” – whenever it starts – extending the argument that other (liquidity) normalization can start even with an accommodative stance.

The inflation transience continues but risks remain

The overall inflation and growth narrative on net was largely the same as the Aug’21 policy. But there were mentions of the risks of inflation (and inflationary expectations) becoming more persistent due to the so-called transient supply shocks and margin increases. The case against higher administered fuel prices was again stressed by a few members. Even as growth remains sub-par, Dr. Patra noted that core inflation may stay sticky due to Covid-related margin increases and tax hikes even as some supplyside mismatches are easing.

The growth narrative was largely similar across the board, stressing the need for a durable recovery. Even the dissenter Prof. Varma also agreed to keep the repo rate at 4.0% on the back of sub-par growth, albeit arguing (along with Prof. Goyal) that policy accommodation and liquidity normalization can coexist. Governor Shaktikanta Das, on the other hand, argued that the risk-reward still favors maintaining congenial financial conditions and fiscal boosters.

Emerging differences among members may have implications on October MPC

While the need to support the recovery remains the predominant view, the (dis)comfort with inflation dynamics is certainly dividing the MPC members. The overall tone of the minutes is slightly more hawkish than the policy itself, but we still think state-based actions and guidance will lead the show in the end. We expect inflation to ease in FY22 (Emkay: 5.35%, RBI: 5.7%), which could give the RBI more room to manage expectations. Interestingly, the core RBI MPC on net seems more convinced that normalizing the policy early would be a mistake – as was also seen in the recent bulletin authored by Dr. Patra. It also argued that, rather than monetary policy, fiscal policy should play a bigger role in influencing supplydriven inflation.

The Aug’21 minutes do little to change our view that the enhanced VRRRs to mop up liquidity are not to be seen as a reversal of the policy stance but simply as normalization of liquidity skewness. We expect VRRRs to be gradually increased further either on tenor or amounts to normalize liquidity skewness. We do not see a reverse repo hike this calendar year. We reckon the RBI will continue to strive to fix the artificially skewed yield curve and maintain its preference for curve flattening.

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