RBI Monetary Policy: Dovish Central Bank Continues To Focus On Supporting Growth Recovery

In order to continue providing support to growth, the Monetary Policy Committee kept all key policy rates unchanged in the Reserve Bank of India’s February policy review meeting, along with an unchanged accommodative monetary stance, while delivering an extremely dovish outlook as far as the CPI inflation trajectory is concerned. We, along with a majority of other market participants, had expected the RBI to hike the reverse repo rate at least by 20 basis points in the current policy, but the central bank decided to surprise once again, by staying on the sidelines, as it did in the December 2021 policy.

What To Expect Next

• We are forecasting the RBI to hike the reverse repo rate by 40 bps in the April policy and change the accommodative stance to neutral.

• We expect the RBI to announce ‘Operation Twist’ in the April policy, to support the bond market.

• We expect the MPC to hike the policy repo rate (currently at 4%) cumulatively by 50 bps in 2022, taking it up to 4.50% by end-December 2022.

• The first 25 bps repo rate hike is likely in June, followed by another 25 bps in the October policy.

• This will still keep real interest rates negative by 70 bps, as we expect CPI inflation to average 5.2% in FY23 under our base case scenario (versus RBI’s forecast of 4.5%).

• We expect another 75 bps of repo rate hike in 2023 and a last 25 bps repo rate hike in 2024, which will take the terminal repo rate up to 5.50%, from 4.0% currently.

In this article, we discuss the key takeaways from the monetary policy in detail.

Reverse Repo Rate Has Become Almost Irrelevant

By holding reverse repo rate at 3.35%, when most short-term rates have already shifted higher towards the repo rate of 4.0%, RBI has effectively rendered the reverse repo rate irrelevant. Interestingly, RBI decided to conduct variable rate repo operations of varying tenors as and when warranted depending on the evolving liquidity conditions.

It was mentioned that “effective reverse repo rate” has risen to 3.87% currently, from 3.37% in August 2021, which goes to show that the reverse repo rate at 3.35% has lost its relevance. Even with the reverse repo rate maintained at 3.35%, short-term interest rates will clear at higher levels given the ongoing VRRR auctions, as is the case currently. However, narrowing the corridor would have made more sense, given where short term interest rates are already clearing at this point of time.

In Backdrop Of U.S. Fed Path, RBI Should Have Hiked Reverse Repo By Now

Our view was that the RBI will maintain the accommodative stance in the February policy, which will likely change to neutral in the April policy, with a repo rate liftoff likely only from the June policy. The February policy does not alter this baseline view, though we were of the opinion that it would have been a better strategy to raise the reverse repo rate in clips of 20 bps in the February and April policy.

Also, given that the U.S. Federal Reserve is likely to start hiking from March itself and that there could be couple of back to back rate hikes, we think the RBI should have already started guiding the market for a repo rate hike in the near future, by starting to narrow the corridor between repo and reverse repo rate by now. The RBI did not prefer to tweak the reverse repo rate, given the continuation of accommodative stance, which we find surprising, as we had thought (going by the previous MPC minutes) that the change of stance is linked with a probable change in repo rate, not the reverse repo rate.

RBI’s FY23 CPI Inflation Forecast Lower Than Our Estimate, Growth Forecast Seems Reasonable

RBI retained its CPI inflation forecasts for January-March 2022 and FY23 at 5.7% and 5.3% respectively, while lowering the April-June 2022 CPI forecast a tad to 4.9%, from 5.0% earlier. The July-September 2022 CPI forecast was kept unchanged at 5.0%, while H2FY23 CPI forecast was pegged at 4.1% average, leading to an overall 4.5% forecast for FY23.

Compared to our baseline CPI inflation forecasts (5.2% average for FY23), RBI’s forecasts are lower by 70 basis points. As far as the quarterly profile of CPI is concerned, our own estimates are 5.9% average forecast for January-March 2022, 5.5% for April-September 2022 and 5.0% for H2FY23, leading to a fiscal year average CPI forecast of 5.2%.

Petrol, diesel and LPG prices have been kept unchanged since November 2021, during which global oil prices have risen nearly 20%.

We think Brent at $90/barrel (which is 20% higher than RBI’s baseline estimate of $75/bbl in October 2021), if sustained, can potentially add another 30-40 bps upside risk (direct + indirect impact combined) to headline CPI inflation, which can push up our baseline FY23 CPI average forecast of 5.2% to 5.5-5.6% eventually.

We are forecasting India’s real GDP to grow by 7.5% year-on-year in FY23, which is already lower than IMF’s growth estimate of 9.0% YoY and RBI’s current forecast of 7.8% YoY. If global oil prices sustain around $90/barrel, it will potentially add to incremental stress to households’ balance sheet, reduce real income and probably result in further increase in inflation expectations, which could then lower medium-term growth prospects.

Kaushik Das is India Chief Economist, Deutsche Bank AG.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.