View: Final status quo RBI monetary policy review

We expect the Monetary Policy Committee (MPC) to hold rates and keep the policy stance unchanged in its February 2022 review, with the third wave preventing the growth recovery from attaining durability. However, with inflationary pressures remaining elevated, we believe that policy normalisation is around the corner. The Central Bank’s communication is likely to provide signals for the same, given that omicron-led uncertainty and the third wave have subsided relatively quickly with an expectedly modest impact on growth.

The MPC had maintained the status quo on policy rates in its December policy meeting. Besides, five of the six MPC members had also voted in favour of continuing with the accommodative policy stance for as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward. Interestingly, while the Central Bank had remained cautious on the growth recovery in line with its ongoing commentary, it had subtly modified the growth-inflation balance, by commenting that price stability remained the cardinal principle of monetary policy.

On growth, the MPC had highlighted that while the recovery was gaining traction, activity was just about catching up with pre-pandemic levels thereby stressing the need for continued policy support. Besides, Deputy Governor Dr. Michael Patra, in the post-policy press conference, had also highlighted that the output gap was ‘very very wide and may take several years to close’.

A modest broad basing of the recovery was witnessed in Q3 FY2022 relative to Q2 FY2022, with a larger number of high-frequency data points reported an increase in volumes relative to pre-Covid levels (Q3 FY2020). Subsequently, the rapid spread of the omicron variant and the imposition of restrictions by state governments moderated activity in January 2022, particularly in the contact intensive services segment and big-ticket consumption. This may trigger a downward revision in the RBI’s Q4 FY2022 and full-year FY2022 projection of 6 percent and 9.5 percent, respectively.

The MPC will also likely issue growth forecasts for FY2023 in its policy meeting, which are keenly awaited. At ICRA, we expect GDP to expand by 9 percent in FY2023, marginally higher than our estimate of 8.9 percent in FY2022. However, growth in FY2023 is likely to be more broad-based and tangible as compared to the base effect led surge in FY2022.

The GoI has clearly prioritised growth over fiscal consolidation in its Union Budget for 2022-23, with the fiscal deficit budgeted at 6.4 percent of GDP for FY2023, well above market expectations. It hiked Central and PSU capex by 10.4 percent in FY2023, while laying down reasonable revenue and nominal GDP assumptions. The RBI and MPC are unlikely to view the limited fiscal consolidation unfavourably, given that the central bank has repeatedly stressed on the need for sustained policy support to make growth broad-based.

On an unpleasant note, the CPI inflation had surged from 4.9 percent in November 2021 to a six-month high of 5.6 percent in December 2021, and is likely to have climbed further to 5.9 percent in January 2022. While the Q3 FY2022 print, at 5.0 percent, was slightly lower than the RBI’s projection of 5.1 percent, we expect CPI inflation to overshoot the central bank’s Q4 FY2022 projection of 5.7 percent. Consequently, the full year FY2022 inflation print is expected to come in at 5.5 percent, slightly higher than the RBI’s projection of 5.3 percent.

The FY2023 CPI inflation forecasts will also be released along with the policy decision, and the Central Bank’s projections and commentary around the trajectory of inflation would be crucial to determine policy action through the year. We expect CPI inflation to ease to 5 percent in FY2023, with risks tilted to the upside owing to the continued pass-through of elevated cost pressures to end consumers.

While the MPC is expected to maintain status quo in the February policy review, it is likely to signal towards policy normalisation in the near term. We believe that this will only play out very gradually with the rate hike cycle being quite shallow given concerns around the durability of growth and the large output gap. We expect the MPC to change the monetary policy stance to neutral and hike the reverse repo rate by 15bps in the April 2022 policy. While we are penciling in two rate hikes — of 25bps each in the June 2022 and August 2022 policy meetings, we expect an extended pause thereafter, until there is a tangible improvement in the durability of growth. The rate hikes are also expected to be accompanied with a calibrated reduction in the liquidity surplus.