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View: Growth revival remains centre-stage

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With an uneven domestic recovery that is deemed to be critically dependent upon policy support, and inflation concerns being dominated by supply-side issues, the status quo on rates and stance by the Monetary Policy Committee (MPC), along with a calibrated move towards liquidity normalisation by the Reserve Bank of India (RBI), was entirely along expected lines.

View: Growth revival remains centre-stage
With an uneven domestic recovery that is deemed to be critically dependent upon policy support, and inflation concerns being dominated by supply-side issues, the status quo on rates and stance by the Monetary Policy Committee (MPC), along with a calibrated move towards liquidity normalisation by the Reserve Bank of India (RBI), was entirely along expected lines.
The October 2021 policy decisions of the MPC replicated the August 2021 outcome, with a unanimous status quo on the repo rate at 4.0 percent, and only one of the six members expressing reservations on the continuation of the accommodative stance of monetary policy.
Moreover, the RBI kept the reverse repo rate unchanged at the low 3.35 percent, despite the recent higher cut-offs in the variable rate reverse repo (VRRR) auctions. As expected, the Central Bank moved towards liquidity normalisation with a calendar for 14-day VRRR auctions, along with the hint that 28-day auctions may be considered if deemed appropriate, to manage the surplus systemic liquidity.
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Following the Government of India’s (GoI’s) borrowing calendar for H2 FY2022, which effectively subsumed the additional borrowing for the back-to-back GST compensation loan to be provided to the states within the original budgeted borrowings, the RBI has indicated a warranted pause in the Government-securities acquisition programme (G-sap).
The MPC modestly reduced its inflation forecast for FY2022 to 5.3 percent with risks broadly balanced, from the 5.7 percent projected in the August 2021 review. While a benign outlook for the kharif harvest and rabi sowing is expected to contain prices of many food items, concerns remain on account of the surge in the prices of edible oils, which are imported to a significant degree, as well as commodities such as fuels and metals. Moreover, shortages of key industrial inputs and surging logistics costs have clouded the outlook for domestic core inflation. For instance, the unfolding coal shortage is expected to seep into higher costs of power and inputs for sectors such as metals, posing a concern for the inflation outlook.
The MPC maintained its view that real GDP will expand by 9.5 percent in FY2022. While the Q1 FY2022 GDP growth fell short of its projections (+20.1 percent vs. +21.4 percent), the Committee has revised up its forecasts for Q2 FY2022 (to +7.9 percent from +7.3 percent) and Q3 FY2022 (to +6.8 percent from +6.3 percent). Subsequently, a high base is expected to temper the GDP growth in Q4 FY2022 to 6.1 percent, despite the expected back-ended boost to contact-intensive services as the pace of vaccinations widens.
Looking ahead, we expect monetary policy to remain accommodative for as long as possible, to avoid any surprise derailment of the growth revival. It is not entirely clear whether the RBI will choose to hike the reverse repo rate as early as December 2021, or postpone it to Q4 FY2022.
We anticipate that the stance of monetary policy will be changed to neutral from accommodative in February 2022, with a hike in the repo rate of 25 bps each in the April 2022 and June 2022 meetings. This is likely to be followed by a pause to reassess the durability of the growth revival as the policy support is weaned off. As a result, real interest rates are likely to remain negative over the next 12 months.
The assurance from the RBI Governor that surprises will be avoided and liquidity normalisation will be gradual and calibrated, with a focus on orderly completion of the government borrowing programme and orderly evolution of the yield curve, should go a long way in tempering the market’s nervousness. Nevertheless, with the pause in the G-SAP programme, the surge in crude oil prices and imminent tapering by the US Federal Reserve Bank, G-sec yields are unlikely to ease meaningfully, as the market prepares itself for eventual policy normalisation.
—Ramnath Krishnan is President Ratings, ICRA Ltd. Views expressed are personal
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