MPC Preview: The Second Covid-19 Wave Will Ensure A Dovish Pause

Stuck between the second wave of Covid-19 infections and elevated inflation, India’s Monetary Policy Committee is likely to take the ‘do-nothing’ option this week. The six-member committee meets for the first time this financial year, armed with a renewed commitment to keep inflation at 4 (+-2)%.

All of the 27 economists polled by Bloomberg expect the central bank to maintain a status quo. The policy repo rate is currently at 4%, while the reverse repo rate is at 3.35%.

Indranil Sen Gupta and Aastha Gudwani, India economists at the BofA Securities, expect another “dovish pause” from the MPC, especially with Covid-19 cases rising. They expect the MPC to stay on hold through FY22 and hike rates by 100 basis points only in FY23. “We continue to believe that the trigger point for tightening will climb towards 6%, stated,” Sen Gupta and Gudwani said.

Growth: A New Wave Of Worry

The Indian economy returned to expansion in the quarter ended December and is expected to see a growth of about 1% in the quarter ended March. However, with a surge in new Covid-19 infections, sequential growth may slip thereafter.

Given the continued rise in cases and the likelihood of more state-wide restrictions, we expect softer sequential growth in Q1 FY22, Nomura said in a report on March 5. A Business Resumption Index computed by Nomura saw a sharp drop to 90.7 for the week ending April 4 from 94.6 the prior week—the steepest weekly fall since mid-April last year.

There will likely be some re-assessment of the growth outlook even as the RBI may not rush to reduce its FY22 growth forecast of 10.5% dramatically, said Madhavi Arora, an economist at Emkay Global.

Rising Inflation Can’t Be Ignored

Yet, the MPC will no longer be able to ignore inflation.

Retail inflation rose to a three-month high of 5.03% in February as food prices saw a modest bounce back. Since the last MPC meeting, core, food, and fuel inflation have all risen.

Under the prevailing circumstances, maintaining retail inflation at 4% with a margin of 2% on either side may pose challenges, with the aggregate fiscal deficit of about 10.8% of the GDP for FY22, said Govinda Rao, chief economic advisor at Brickwork Ratings.

While inflation is currently in the target range, going forward, excess liquidity in the system, combined with volatility in crude oil prices, can pose an upside risk, Rao said. Once the current output gap narrows, surplus liquidity conditions could put pressure on prices, and the RBI will have to be vigilant, said Rao, while acknowledging that the second wave of Covid infections may leave the MPC will little choice but to maintain an accommodative policy stance for now.

Liquidity: Excesses To Continue

At the time of the last MPC, the RBI had decided to gradually restore a 100-basis-point cut in the cash reserve ratio in two phases. However, Governor Shaktikanta Das had assured the market that liquidity would remain comfortable and a reversal of the CRR cut will give the central bank space to conduct larger bond purchases.

Rao said in the current scenario the RBI may like to drain in excess liquidity. But given the higher government borrowings, which may put pressure on bond yields, the RBI may go slow in reversing its liquidity measures.

According to Sen Gupta and Gudwani, the RBI will likely try to fund the fiscal deficit without adding to surplus liquidity.

Bond Market: Uneasy Calm

The central bank will also not want to disturb the uneasy calm in the bond markets. After a jump in yields following the Union budget and the policy review in February, the benchmark 10-year bond yield has settled close to 6.15%

The RBI will again assuage markets and continue to ensure that no premature tightening of financial conditions would happen, said Arora. The central bank will strive to fix the skewed yield curve to keep longer-term rates in check, she said.