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    RBI monetary policy preview: Guidance to reflect cautious optimism

    RBI monetary policy preview: Guidance to reflect cautious optimism

    RBI monetary policy preview: Guidance to reflect cautious optimism
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    By Radhika Rao   IST (Updated)

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    In the first policy review for FY22, the Reserve Bank of India (RBI) monetary policy committee (MPC) is expected to keep benchmark rates unchanged accompanied by an accommodative bias.

    In the first policy review for FY22, the Reserve Bank of India (RBI) monetary policy committee (MPC) is expected to keep benchmark rates unchanged accompanied by an accommodative bias. Developments since the February review—sticky inflation and an increase in COVID cases—are likely to influence the policy guidance.
    February CPI inflation ticked up to 5 percent, owing to the pass through of higher selected food items and fuel price pressures, accompanied by stickier core readings. With the March inflation print poised to be close to February’s, the central bank is expected to highlight the rise in global commodity prices (oil and beyond), rising input prices and demand impulse as factors driving inflation. A return in manufacturers’ pricing power is also visible in the recent PMI as well as RBI’s latest industrial and business surveys. While the initial impact will be more visible in wholesale price inflation, which has a heftier weight of commodities, this could carry pass-through risks for retail inflation down the line.
    After close to six months of a receding case count, India is witnessing a rise in the COVID-19 cases back to 80,000+ cases/day, along with a higher positivity rate as well as an uptick in the R0 gauge. In response, states have imposed localised restrictions as well as efforts to expedite the vaccination rollout, steering clear of broader lockdowns. Mobility trends, which were under watch as an initial marker for economic impact, have begun to soften particularly in states that face a rising tide of cases. This might persist on two counts—either by way of pre-emptive caution by households or official restrictions restraining movement. There is likely to be renewed caution on the sequential growth trend into 1QFY22, with most year-on-year trends likely to be influenced by base effects.
    In terms of forecasts, the average inflation forecast for January-March 21 might be lowered to 4.7-4.9 percent from 5.2 percent estimated at the last review, whilst the rest of the path is maintained. We don’t expect any change in the FY22 forecast at 10.5 percent, with our forecast also in line with the central bank’s. For the upcoming monetary policy report, oil assumptions will need to be raised in light of the recent gains.
    Prior to this outbreak, we had expected policy normalisation pressures to surface in 2Q owing to a cyclical rebound, along with firmer core inflation and commodity price increases. With the recent rise in COVID cases and yet sticky inflation, monetary policy normalisation to be pushed back as authorities monitor developments closely, with status quo on the cards on the repo, reverse repo as well as liquidity management plans for 1H21. Recovering lost output due to the pandemic will take time, clouded further by the onset of the second wave, leaving the central bank more tolerant of a cyclical upcycle than previous occasions and not rush to exit an accommodative policy bias in a hurry.
    The review of inflation goals ended with the targets being maintained unchanged at 4 percent (+/-2 percent), along our expectations. With the current framework exhibiting sufficient flexibility in a challenging 2020 in midst of the pandemic, as well as helping to anchoring inflationary expectations through the last five years, there was likely little impetus to tweak the parameters as yet.
    Besides mainstream policy, the central bank will seek a smooth borrowing program, with the April policy providing a window to bridge the communication gap with the market participants. The borrowing calendar points to 60 percent of the FY22 issuance being frontloaded, with the tenor mix (lower 10Y papers and higher ultra-long vs 1HFY21) seen as steps to better balance the demand-supply mix at a time when rates are broadly drifting higher.
    If global market volatility accompanies, the central bank will need to manoeuvre a challenging balance beam, capping bond yields, staying pro-growth, and keeping liquidity flush yet keep inflation under control. Most of the policy tightening pressures are emanating from adjustments in global markets, with rate hike bets as captured by implied rates seen as being premature. Meanwhile, the central bank might draw relief as the rupee caught up with the regional FX weakness, upon the passage of equity-related flows which had temporarily shielded the currency from broad dollar strength.
    Radhika Rao, an
 economist, is senior vice-president, DBS Bank, Singapore. The views expressed in the article are personal
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