Monetary policy: RBI surprises with dovish note as growth concerns weigh

Repo rate unchanged at 4%; stance 'accommodative'

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) on Thursday took a dovish stance that was contrary to expectations of a formal step of policy normalisation by hiking the reverse repo rate.

All the six members voted to keep the repo rate unchanged for the 10th consecutive policy meeting, and one dissented on maintaining the “accommodative” stance.

The MPC flagged the potential downside risks to economic activities from the contagious Omicron variant of Covid-19 and observed some loss of momentum as reflected in high-frequency indicators -- such as the purchasing managers’ indices for both manufacturing and services, and finished steel consumption and sales of tractors, two-wheelers, and passenger vehicles -- while adding that the demand for contact-intensive services was still muted.

GDP growth for the next fiscal year was projected at 7.8 per cent, lower than what the Economic Survey kept at 8-8.5 per cent.

“Overall, taking into consideration the outlook for inflation and growth, in particular the comfort provided by the improving inflation outlook, the uncertainties related to Omicron and global spillovers, the MPC was of the view that continued policy support is warranted for a durable and broad-based recovery,” Das said while announcing the policy review.

Bond yields fell after the policy announcement. Yields on the 10-year government bond fell 7 bps to close the day at 6.73 per cent. The benchmark equity indices also ended higher for a third straight day on Thursday following the policy. The Sensex ended at 58,926, a gain of 460 points, or 0.8 per cent. The Nifty, on the other hand, closed at 17,606, up 142 points or 0.8 per cent. The rate-sensitive Nifty Financial Services and Nifty Realty indices gained about a per cent each.

The market was surprised by the central bank’s inflation projection, pegged at 4.5 per cent, for the next fiscal year, despite crude oil prices hovering above $90 a barrel, which has prompted many global central banks to turn hawkish.

“On balance, headline inflation is expected to peak in Q4:2021-22 within the tolerance band and then moderate closer to target in H2:2022-23, providing room for monetary policy to remain accommodative,” Das said.

He said the inflation number was arrived at after taking various scenarios into consideration while adding the nature of inflation was different in India compared to that of other nations, and emphasised that the central bank was not behind the curve.

“The RBI’s defence it is not behind the curve comes from its rigorous analysis and forecast on the likely inflation trajectory ahead,” said Suyash Choudhary, head (fixed income), IDFC AMC.

“This assessment is markedly different from most of the private sector forecasts. It is then a matter really about who turns out to be right on the assessment eventually,” Choudhary said.

Aurodeep Nandi, India economist and vice-president, Nomura, said: “Sometimes the markets expect the dessert, but then realise that the main course is still not over.”

“The RBI surprised by not only doubling down on its now familiar orthodoxy of keeping rates and stance unchanged, but also expressed a very dovish outlook for inflation for FY23, forecasting it at 4.5 per cent. This comes despite higher oil and commodity prices, growth-supporting fiscal policy, continued economic normalisation, and a distinctly hawkish Federal Reserve,” Nandi said in a note.

Though the central bank refused to walk the policy normalisation path, it decided to roll back some of the relaxation offered in the last two years with respect to liquidity management.

“With the progressive return of normalcy, including transient demand for liquidity from the RBI, it is logical to restore the revised liquidity management framework in order to make it more flexible and agile,” Das said.

Four steps were announced to restore the liquidity framework. First, variable rate repo operations of varying tenors will be conducted within the cash reserve ratio (CRR) maintenance cycle. Second, variable rate repos (VRRs) and variable rate reverse repos (VRRRs) of a 14-day tenor will operate as the main liquidity management tool. Third, these main operations will be supported by supplementary action to tide over any unanticipated liquidity changes during the reserve maintenance period and suctions of longer maturity will also be conducted as needed, and, fourth, fixed rate reverse repo and the marginal standing facility operations will be available for a shorter period from next month.