RBI Policy: Subtle shift in growth-inflation balance

The December 2021 monetary policy review threw up no major surprises. With the fresh uncertainty engendered by the Omicron variant, the Monetary Policy Committee (MPC) expectedly maintained status quo on the rates and stance. Even the number of dissents to maintaining the stance as accommodative remained stable at one vote out of the six MPC members. While keeping the reverse repo rate unchanged, the Reserve Bank of India (RBI) emphasised the objective to re-establish the 14-day variable rate reverse repo auction as the chief liquidity management operation.

The annual GDP and inflation forecasts for FY2022 were kept unchanged at the October 2021 expectations of 9.5 per cent and 5.3 per cent, respectively, with some recalibration of the quarterly forecasts. For instance, the GDP growth in Q2FY22 had exceeded the MPC's estimate (+8.4 per cent vs. +7.9 per cent), and the Committee has now pared its expectations for Q3FY22 (to +6.6 per cent from +6.8 per cent) and Q4FY22 (to +6.0 per cent from +6.1 per cent), suggesting that the outcome in the just-concluded quarter benefitted from an upfronting of pent-up demand. Moreover, the growth estimates for H2FY22 have been revised downwards in spite of the larger-than-expected net cash outgo in the Government of India's second supplementary demand for grants. The Committee has retained its October 2021 GDP growth forecast for Q1FY23 at 17.2 per cent and projected the Q2FY23 growth to moderate to 7.8 per cent, led by the normalising base.

While a note of optimism was struck on the domestic recovery gaining traction, it was highlighted that the Indian economy is not immune to either global spill overs or to fresh waves of Covid-19. Moreover, the comment on managing a durable, strong, as well as inclusive recovery, underscores concerns of a K-shaped trend underpinning the traction in economic growth. The MPC also remarked that the ongoing domestic recovery needs sustained policy support to make it more broad-based, revealing the caution around its durability.

The MPC retained its October 2021 CPI inflation forecast for FY22 at 5.3 per cent, with risks broadly balanced, offsetting an upward revision for Q3FY22 (to +5.1 per cent from the earlier +4.5 per cent), with a mild downward revision for Q4FY22 (to +5.7 per cent from +5.8 per cent). For the subsequent quarters, the MPC has projected the CPI inflation to soften to 5.0 per cent each in Q1FY23 (lower than the +5.2 per cent forecast made in October 2021) and Q2FY23. Regardless, the Committee remarked on the need for continued normalisation of excise duties and VATs accompanied by measures to address other input cost pressures, to sustainably lower core inflation as demand recovers.

In our view, today's policy subtly modified the growth-inflation balance, by commenting that price stability remains the cardinal principle of monetary policy. Based on this, we maintain our base case assessment that the monetary policy stance will be changed to neutral in the February 2022 policy review, as long as no third wave emerges in the interim. We continue to expect a 15-bps hike in the reverse repo rate by the RBI in February 2022, narrowing the policy corridor to 50 bps from the current 65 bps. 

Thereafter, we foresee hikes of 25 bps each in the repo and reverse repo rates each in the April 2022 and June 2022 reviews, followed by a reassessment of the durability of the growth revival as policy support is withdrawn.

Nevertheless, the overarching tone of today's statement and forward guidance is less hawkish than what we had anticipated. With the MPC remarking that the ongoing domestic recovery needs sustained policy support to make it more broad-based, the likelihood of our base case materialising has admittedly moderated. 

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Aditi Nayar is Chief Economist at ICRA. Views are personal.