The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) will meet between 6-8 December 2021 to take stock of the unfolding macroeconomic conditions and to debate and decide on the future monetary policy direction. Though for the last four months (July to October 2021) the consumer price inflation (CPI) is well within the target of the RBI (Figure 1; inflation within 2 to 6%) there is pressure on the central bank to normalize its monetary policy given the fact that there is excess liquidity in the banking system. The RBI had created this excess liquidity to ease the government borrowing in wake of Covid’19 but keeping the system in high liquidity for long may lead to asset price bubbles in stock and bond markets.

Figure 1: Inflation rate in India

On the other hand, bank loan growth which may be taken as a proxy to gauge investment demand in the economy has just started to take off (Figure 2) and any increase in the repo rate (the RBI’s policy rate) will adversely affect loan demand.

Figure 2: Bank Loan Growth in India

Complicating the matter for the RBI is the high inflation rate in the USA (Figure 3) which may force the Fed Reserve to tighten its monetary policy much before what the Fed Governor Dr. Jay Powell earlier communicated to the market. With the tightening of the USA monetary policy, there may begin a great Indian sale in the stock and bond market resulting in a significant depreciation of the Indian rupee (remember Taper tantrum of 2013).

Figure 3: Inflation in the USA

Under this prevailing scenario, the MPC will meet to decide the future monetary policy path in India. If the bond market is to be believed, it is already preparing for higher interest rates in the future as the 10-year government bond yield has increased from 6% on Jun 1, 2021, to 6.33% on 26 November 2021.