In the bi-monthly review held between Dec 6-8, 2021, Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained status quo on repo rate in line with expectations while also retaining the accommodative policy stance. In a similar outturn vis-à-vis the previous review meets in Aug-21 and Oct-21, while the former was backed by complete unanimity (6-0 vote), the later saw a dissent voice (5-1 vote).

While the MPC outcome of a status quo on repo rate was anticipated by all market participants, few were expecting the RBI to formally initiate interest rate normalization via a hike in the reverse repo rate. While Acuité did have a similar expectation, MPC’s gradual approach towards normalization along with the emergence of a new Covid variant ‘Omicron’, had increased the likelihood of a postponement of this decision to Q4 FY22. Expectation of interest rate normalization had gained traction with gradual calibration of money market liquidity surplus, improvement in sequential economic recovery, and commencement of monetary policy normalization by various central banks across the world. The RBI, however, chose to maintain status quo on the interest rates including keeping the reverse repo rate unchanged at 3.35% to ensure that India’s economic recovery that is underway becomes "durable, strong, and inclusive” while downside risks from global spillovers (a potential resurgence in Covid, persistent supply disruptions, and divergence in monetary policy trajectories) gets mitigated.

Economic Assessment

Growth: The RBI retained its FY22 GDP growth forecast at 9.5%. Going forward, the central bank expects GDP growth to average at 12.5% in H1 FY23 vis-à-vis the average growth of 14.3% seen in H1 FY22. The MPC expects growth momentum to find support from expanding inoculation coverage, improvement in retail mobility, emphasis on public capital expenditure, structural reforms like the PLI Scheme, and benign liquidity and financial conditions, besides a temporary boost from pent-up demand that is emerging due to complete unlocking of the economy. 

However global risks (as cited above) could dampen the recovery momentum with heightened uncertainty on account of the likely spread of the Omicron variant. 

In the absence of a severe third wave of Covid infections (triggered by Omicron), Acuité  continues to expect FY22 GDP growth at 10.0%, albeit with some downside risk. 

Inflation: While the RBI retained its FY22 CPI inflation forecast at 5.3%, it revised its forecast for CPI inflation in H2 FY22 slightly to 5.4% from 5.2% earlier. Going forward, the central bank expects CPI inflation to average at 5.0% in H1 FY23 vs. 5.4% in H1 FY22.

Overall, CPI inflation is projected by the RBI to remain in the 5.0-5.7% range in the next four quarters. While input cost pressures, global logistics and supply chain bottlenecks (albeit easing somewhat recently) continue to impinge upon core inflation, the central bank has highlighted comfort on non-core factors like food (likely to benefit from the incoming kharif produce as well as improvement in rabi acreage) and fuel (owing to some moderation in energy prices along with reduction in domestic petroleum taxes and duties).

While we acknowledge the likely disinflation from food and fuel in the near term, we expect core inflation to remain elevated on account of the ongoing pass through of higher input costs across the manufacturing and the services sectors (for e.g., the hike in tariffs by telecom companies alone could add 25 bps to headline inflation and increase in GST rate for select clothing and footwear items from Jan-22). In addition, prolonged supply chain bottlenecks and raw material shortages could keep inflation risks skewed to the upside. Hence, we continue to attach an upward bias to RBI’s inflation forecast with our FY22 estimate at 5.5% in FY22. 

Liquidity and Credit Measures

The RBI continues to focus on a gradual calibration of liquidity. Under the ambit of ongoing rebalancing of the liquidity surplus, the central bank will continue to emphasize further on VRRR auctions. The outstanding amount offered under the 14-day VRRR auction is set to increase from the current level of Rs 6.0 trn to Rs 7.5 trn by the end of Dec-21. In addition to the 14-day operation, the central bank would continue to fine tune liquidity surplus via longer term VRRR auctions as and when required. Consequently, from Jan-22 onwards, liquidity absorption will be undertaken mainly through the auction route. 

In addition to these, the RBI also announced:

• Banks will now have the option to prepay the outstanding amount of funds availed under the Targeted Long-Term Repo Operations (TLTRO 1.0 and 2.0 announced in Mar-20 and Apr-20 respectively). The current outstanding under TLTRO 1.0 and 2.0 is at Rs 756 bn. This could get utilized as banks seek to optimize their liquidity position by repricing at lower rates.
• In the light of limited utilization, the emergency recourse to the MSF window for availing additional liquidity worth 1% of NDTL provided at the start of the pandemic will be withdrawn from Jan-22.
• The central bank proposed to encourage digital transactions through (i) launch UPI-based payment products for feature phone users, (ii) make the process flow for small value transactions simpler through a mechanism of ‘on-device’ wallet in UPI applications, and (iii) enhance the transaction limit for payments through UPI for the Retail Direct Scheme for investment in g-secs and IPO applications from Rs 2 lakh to Rs 5 lakh. This will deepen digital payments and make them more inclusive,

Outlook on monetary policy and rates

Expectation of an improvement in sequential growth along with continued emphasis on recalibration of liquidity surplus will keep alive chance of a modest hike in the reverse repo in Feb-22 policy review. Besides getting clarity on the spread and virulence of Omicron, the next two months will provide crucial information on the pace of Fed’s taper operations (along with timing of liftoff) along with central government’s, fiscal policy strategy and design for FY23 through the publication of the Union Budget. However, any deterioration in growth outlook on account of Omicron can reinforce the ‘wait and watch’ approach of RBI, thereby resulting in further postponement of normalization of the policy rate corridor.