RBI monetary policy signals change in stance for June 2022

Next RBI monetary policy stance likely to be followed by shallow rate hike cycle, with the repo rate being increased by 25 bps each in August and September 2022.

The first monetary policy review meeting for FY2023 was rather eventful, coming in the backdrop of an easing of the pandemic and a flaring up of geopolitical tensions. The Monetary Policy Committee (MPC) maintained status quo on the repo rate and kept the stance accommodative, in line with our expectations. However, it normalised the width of the liquidity adjustment facility (LAF) corridor to pre-pandemic levels by introducing the Standing Deposit Facility (SDF) at 3.75% as the floor rate, in place of the fixed rate reverse repo (FRRR), which was kept unchanged at 3.35 per cent. This move would enable the central bank to absorb liquidity without providing any collateral, augmenting its toolkit.

Interestingly, the Committee pointedly modified its comments around the stance, clearly stating that it would focus on the withdrawal of accommodation going ahead. The decision on the stance was unanimous, unlike the past few policy reviews. 

Presciently, the monetary policy document chose to prioritise inflation over growth in its outlook statement, in contrast with the previous policy documents, wherein the commentary on growth preceded inflation. Given the consistency in the sequencing of commentary seen in the past policy statements, this signals a shift in the ordering of the MPC’s concerns. This corresponds to the changes in the economic landscape following the Russia-Ukraine conflict, with inflationary pressures at the fore following the spike in global commodity prices.

As expected, the MPC lifted its inflation forecast and pared its growth projection for FY2023. The Committee revised its FY2023 inflation forecasts upwards to 5.7 per cent from 4.5 per cent earlier, marginally higher than our own expectations of 5.6 per cent. It highlighted that its projection was based on the assumption of the price of the Indian basket of crude oil averaging at US$100/bbl. It raised its CPI inflation projection for Q1 FY2023 to 6.3 per cent; this is in line with our projection for the quarter, which assumes a full pass through of the pending transmission of the crude price hike to petrol and diesel, without any excise cut.

Besides, the GDP growth projections for FY2023 were cut by the MPC to 7.2 per cent from 7.8 per cent earlier, in line with our forecast for this fiscal. The MPC highlighted downside risks stemming from elevated commodity prices, tightening global financial conditions, uncertainties owing to policy normalization in advanced economies, continued supply side disruptions and weakening global demand. However, it sounded quite optimistic on investment demand, while highlighting the Government of India’s thrust on capex, improving capacity utilization levels and deleveraged corporate balance sheets.

Overall, with the focus shifting to inflation management over supporting growth, and the modification in the wording on the policy stance, the MPC has clearly telegraphed an imminent change in the stance. We see a near certainty of it being revised to neutral from accommodative in the June 2022 policy review. This would be followed by a shallow rate hike cycle, with the repo rate being increased by 25 bps each in August and September 2022.

The RBI Governor highlighted that they would withdraw the liquidity overhang in a gradual and calibrated manner over a multi-year time frame in a non-disruptive manner. However, the RBI’s announcements on changes in the liquidity facilities and the wordings of the policy stance seem to take the bond markets by surprise. The 10-year G-sec yield breached 7.0% after the policy announcement. We anticipate it to rise to as much as 7.4% over the course of H1 FY2023, as the market's views on the number and timing of rate hikes crystallise. Even as the Governor hinted at utilising various tools to manage the government borrowing programme, comments on the yield curve being a public good were missing. This suggests that yields will likely tread a gradual up-move in the next two quarters.

(The writer is Chief Economist, ICRA Limited)