Omicron Risks Force India to Hold Rates, Soak Up Liquidity

(Bloomberg) -- India’s central bank kept borrowing costs at a record-low to ward off risks to economic recovery from the omicron variant, while sponging away excess liquidity to keep inflationary pressures at bay.

The Monetary Policy Committee voted to keep the benchmark repurchase rate at 4%, as predicted by all 35 economists surveyed by Bloomberg. The six-member panel, which has been on pause since August 2020, voted 5-1 to retain its accommodative policy stance for as long as is necessary, reflecting its bias to support economic growth given inflation is within target.

“Our motto is to ensure soft-landing that is well-timed,” Reserve Bank of India Governor Shaktikanta Das said in a live webcast Wednesday. “Managing strong and inclusive recovery is our effort,” he said.

Bonds advanced, with the yield on benchmark 10-year bond falling three basis points to 6.36%, as the RBI belied traders expectations for an increase in the reverse repurchase rate -- the level at which it absorbs excess cash from lenders. The rupee traded little changed, while stocks surged.

“Broadly, the policy is more dovish-than-expected, possibly given the uncertainty from the new Covid variant,” said Suvodeep Rakshit, senior economist at Kotak Institutional Equities. “We expect reverse repo hike of around 20 basis points is possible in the February policy and a tad more aggressive liquidity withdrawal.”

With the omicron variant spreading fast, several nations have responded with varying degrees of pandemic controls that could throttle demand. While there are no new strict curbs in India, the threat of another wave is likely to keep the RBI from taking any aggressive steps to return policy settings to pre-pandemic levels just yet.

“The endeavor of the Reserve Bank is to put in place an effective liquidity management framework that is consistent with an economy emerging out of the pandemic,” Das said, in his first policy speech after being re-appointed for a second three-year term.

The RBI will instead raise the amount of cash it absorbs through the 14-day variable rate reverse repo on Dec. 17 and 31, while making the auctions the main tool of cash-absorption in 2022, shifting away from the fixed reverse repo rate.

The 14-day VRRR will be complemented by longer tenor ones as necessary, Das said, as excess cash in the banking system hovered around 9.2 trillion rupees ($122 billion), close to a record high. The surplus liquidity is seen as a risk to consumer prices, already under pressure from a rise in vegetables and fuel costs.

Headline inflation has remained above the RBI’s 4% medium-term target for 25 consecutive months, although it’s currently within the broader 2%-6% target range.

Policy makers still retained the inflation forecast of 5.3% for the full year, and expect the economy to pull off 9.5% expansion in the year ending March.

“The MPC regarded the accentuation of headwinds emanating from global developments as the main risk to domestic outlook, which is now somewhat clouded by the omicron variant,” Das said. “Given the slack in the economy and the ongoing catching up of activity, especially of private consumption which is still below its pre-pandemic levels, continued policy support is warranted.”

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