RBI Monetary Policy Review: Dove all the way

Mr. Abheek Barua’s Chief Economist, HDFC Bank views on RBI Monetary policy

“The RBI policy announcement was on expected lines as the central bank continued to support growth and sounded caution on the omicron risk. The central bank kept its stance, policy rate and corridor unchanged and did little to provide any forward guidance on the path of future policy rate increases. The RBI kept its inflation forecast unchanged at 5.3% for FY22, signalling that it believes inflation to be more transient than permanent in nature. We expect inflation prints to surprise on the upside and average at 5.6% for FY22, driven by elevated input and fuel costs and as the base effect wanes off. On liquidity normalisation, the RBI continued its auction based rate management policy, moving away from the reverse repo – so far the effective overnight rate – towards the repo rate through liquidity rebalancing from the overnight to the VRRR (variable rate reverse repo) window. We expect this to put further upward pressure on the short-end of the curve”.

The RBI policy announcement was more dovish as compared to our expectations. The central bank kept its stance, policy rate and corridor unchanged and did little to provide any forward guidance on the path of future policy rate increases. This is in contrast to other global central banks (like the US Fed) that are turning towards tightening monetary policy. The policy decision today tilted on the side of caution, continuing its support for growth and sounding caution on the omicron risk.

On liquidity normalisation, the RBI continued its auction based rate management policy, moving away from the reverse repo – so far the effective overnight rate – towards the repo rate through liquidity rebalancing from the fixed overnight to the VRRR (variable rate reverse repo) window. The RBI said that from January 2022 onwards liquidity absorption will be undertaken mainly through the auction route. We expect this to put further upward pressure on the short-end of the curve.

The RBI kept its inflation forecast unchanged at 5.3% for FY22, signalling that it believes inflation to be more transient than permanent in nature. It expects CPI inflation to peak in Q4 FY22 and moderate thereafter. We do not see the inflation trajectory to be as benign and expect inflation prints to surprise on the upside and average at 5.6% for FY22, driven by elevated input and fuel costs and as the base effect wanes off. The risk of prolonged elevated core inflation feeding into household expectations and becoming more entrenched in the system remains.

On growth, the RBI said that while growth momentum is picking up, there are still a number of global risks (supply disruptions, new virus variants, commodity prices volatility, etc.). The central bank retained its growth forecast at 9.5%, assuming no significant resurgence of Covid-19 in India.

Going forward, we expect the monetary policy normalisation process to get a leg up in the February meeting and see the possibility of a reverse repo hike if the omicron virus is managed. We expect a change in stance in the April meeting from accommodative to neutral and a repo rate hike by June or August policy 2022. On liquidity absorption, the RBI is likely to adopt more market-related instruments (longer tenure VRRR, OMOs, etc.).

Market impact: Yields moderated post the RBI’s policy announcement. The 10-year yield is trading lower at 6.36% (as compared to 6.39% yesterday and 6.38% before the policy announcement). We expect the 10-year bond yield to trade close to 6.35-6.40% by December-end and 6-4-6.5% by March end.

The Specifics:

Inflation Outlook: The RBI revised up its inflation forecast for Q3 FY22 by 60 bps to 5.1% while revising down its inflation forecast by 10 bps to 5.7% for Q4 FY22. The RBI kept its forecast for FY22 unchanged at 5.3%, with risks broadly balanced.

The RBI highlighted the risks related to input cost pressures are building up in the economy although, the slack in the economy is muting the pass-through to output prices.

• Our View: We expect inflation to average at 5.6% for FY22. We expect CPI inflation to climb back above 6% from Dec-21 onwards led by higher input prices and as the base effect drops off.

• Growth Outlook: The RBI kept its growth forecast unchanged at 9.5% for FY22. However, it revised its quarterly forecasts. The RBI revised down its forecast by 20 bps to 6.6% for Q3 FY22 and by 10 bps to 6.0% for Q4 FY22. The RBI expects rural demand to remain resilient while a pickup in contact intensive activities and pent-up demand will continue to support urban demand. That said, volatile commodity prices, persisting global supply disruptions, new mutations of the virus and financial market volatility pose downside risks to the outlook.

Key Announcements:
Liquidity Measures:

• Variable Reverse Repo announcement: The RBI has proposed to enhance the 14-day VRRR auction amount on a fortnightly basis in the following manner:

• From January 2022 onwards, liquidity absorption will be undertaken mainly through the auction route.
• Further, the RBI will continue to complement 14-day VRRRs by longer-term VRRRs, the size and maturities of which will be decided on the basis of continuous assessment of the evolving liquidity conditions

• On-tap liquidity windows of INR 50,000 crore for ramping up COVID healthcare infrastructure and services and INR 15,000 crore for contact intensive sectors will continue till March 31, 2022.
• Marginal Standing Facility: The RBI has proposed to return to the normal dispensation under the MSF as the usage of the MSF window has been rare due to surplus liquidity conditions. Banks will be able to dip up to 2% of net demand and time liabilities instead of 3% for overnight borrowing under the MSF from January 1, 2022.