RBI lets Schrodinger’s cat out of the bag, admits rate corrections can’t fight inflation for now

It appears that inflation has entered the state of Schrodinger’s theory, where price rise is both temporary and persistent simultaneously.

On Wednesday, the RBI confirmed that headline inflation will likely peak in January-March 2022, and should ease thereafter. But unlike in the past, Governor Shaktikanta Das has not only retired the ‘transitory’ phase for ‘stubborn’ inflation, but also decided not to take the foot off the policy pedal.

In other words, the textbook remedy for arresting persistent price pressures via rate hikes is off the table and the key policy repo rate will squat at 4% until further notice. A rate hike arrests monetary inflation, or rising prices due to increasing money supply. But given the present inflation is due to global supply bottlenecks, rate corrections are simply useless. So the central bank’s Monetary Policy Committee (MPC), kept key policy rates and stance unchanged. Reverse repo rate too stands at 3.35%. Traditionally, the gap between repo and reverse repo rates is 25 bps and reducing the gap is the first step towards eventual rate hikes.

Just until last week, a hike in reverse repo rate to narrow the rate corridor and set the ground for actual lift-off appeared certain, but that too has been put off until next year, thanks to the trinity of concerns — new virus variant Omicron, persistent price pressures and global supply bottlenecks.

For now, the central bank hopes to align rates without the noise around a rate hike. In fact, it has been doing so since at least since October, where excess liquidity was absorbed via 14 and 28-day Variable Reverse Repo Rate (VRRR) auctions, which in turn firmed up short-term rates. Policywatchers expected a reverse repo rate hike on Wednesday officially confirming a faster policy normalisation, but Governor Shaktikanta Das announced that tapering will now proceed at a fairly leisurely pace.