India’s RBI Stays Accommodative, Warns of ‘Tectonic Shifts’

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India’s central bank signaled a shift in policy focus as it ramped up efforts to mop up excess liquidity in the banking system and raised its inflation forecasts, sending bond yields higher.

While the Reserve Bank of India’s rate-setting panel decided to hold rates and keep its accommodative stance, it also voted unanimously to focus on “withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.”

Governor Shaktikanta Das also announced a new tool that will enable the monetary authority to soak up excess cash in the banking system by narrowing the so-called interest rate corridor.

The statement dropped a pledge to keep policy loose “as long as necessary” for the first time since late 2019. Combined with increased efforts to tighten liquidity, economists said it marked a hawkish shift in the policy outlook.

“The RBI has undertaken a normalization of the corridor effectively, and is preparing the ground for further normalization in coming months,” said Rahul Bajoria, an economist at Barclays Plc. 

India’s 10-year bond yield rose to 7%, the highest since 2019, as the RBI also raised its inflation and lowered its growth forecast. 

What Bloomberg Economics Says...

“The Reserve Bank of India held its policy rate steady but indicated it is now focused on withdrawing accommodation. Changes to its forward guidance dialed back its dovish tone -- an incremental step toward tightening that we expect early next year.”

-- Abhishek Gupta, India economist

For the full note, click here

A recovery in Asia’s third-largest economy is facing fresh challenges from the war in Ukraine and Covid-19 lockdowns in China, which risk exacerbating a global supply squeeze and price pressures. Das said the global economy is seeing “tectonic shifts” from the war and extreme volatility in commodity and financial markets. 

“Caught in the cross current of multiple headwinds, our approach needs to be cautious but proactive in mitigating the adverse impact on India’s growth, inflation and financial conditions,” Das said. 

The decision comes as many central bank peers pivot toward tightening, led by the Federal Reserve, which is expected to continue raising rates when it meets in May. Policymakers globally have started shifting their focus toward fighting inflation as recoveries from the pandemic begin to take hold.

A key announcement in the policy statement was the introduction of a new tool to soak up excess liquidity. The so-called Standing Deposit Facility will absorb cash from banks at 3.75%, with the central bank not having to provide any collateral in exchange.

The new mechanism, which was first proposed in 2014, will now form the floor of the interest rate corridor, basically pushing up the overnight rates without any direct tightening of policy. Earlier the floor was the reverse repo rate, at 3.35%.

Shorter bond yields led the jump in response to the announcement, with the four-year bond yield up 12 basis points to 6.15%, while the 10-year yield rose nine basis points at 7%, a level last seen in 2019.

“This policy, in some sense, is a segue to tightening policy rates in the coming months,” said Lakshmi Iyer, chief investment officer for debt at Kotak Mahindra Asset Management. “Expect yields to rise across the curve to reflect the policy stance.”

The central bank raised its inflation forecast to 5.7% for the fiscal year that started April 1, up from its 4.5% in February. The central bank also sees gross domestic product growth during the year at 7.2%, compared with a previous outlook of 7.8%.

“In the sequence of our priorities we have now put inflation over growth,” Das told reporters after the policy announcement. Since February 2019 “we had put growth ahead of inflation in the sequence. This time we have revised that because we thought that the time was appropriate and that is something that needs to be done,” he said.

The RBI’s inflation forecast was a key focus heading into the decision, after drawing criticism from some economists after its last meeting in February for being too relaxed on consumer prices. Russia’s invasion of Ukraine since then has piled on more potential pressures, including a surge in oil prices, leading Das last month to acknowledge the forecast needed to be reworked. He said during the policy statement that the RBI’s new growth outlook assumes crude at $100 a barrel.

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