RBI between a rock and a hard place, no rate hikes likely in FY22, says Barclays

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The report said any potential rate hikes are ruled out for the current financial year, and the repo rate hike- signaling a return to policy normalization- may only happen in the first quarter of the next financial year, FY 2023.

"We think the second wave has delayed the economic normalisation cycle by a quarter or two, both in terms of GDP levels and sectoral recovery. Indeed, we now estimate that India will only reach its pre-COVID level of annual GDP by the end of 2021, compared with mid-2021 earlier; this implies two years of zero growth in activity levels. This also means that the central bank needs to wait and watch growth trends, despite a closing output gap, even if the trajectory of inflation is uncomfortable from a policy perspective," Bajoria said in the report.

Barclays had earlier highlighted an eight-step process for policy normalization by RBI earlier. This included the reduction in short term liquidity temporarily, a cash reserve ratio hike back to stated levels, which has already happened, withdrawal of moratorium on non-performing asset (NPA) recognition- which has also been implemented, switch to a 'state-based forward guidance', gradually normalise the liquidity adjustment facility corridor via reverse repo rate hike, liquidity withdrawal, repo rate hike and shift to a neutral policy stance.

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"CRR hikes, variable reverse repo auctions, and a change in the RBI's guidance from time-based to state-based can be interpreted as steps closer to normalization," the report said.

Despite the repeated assurances from the RBI that it will maintain growth-supportive financial conditions, Barclays noted that there are limits to how long an inflation-targeting central bank can wait before being forced to act on evolving price dynamics.

So far, the RBI has relied on supply-side measures from the government to lower price pressures. If these moves prove ineffective, this could lead to sustained upside pressures on retail inflation, it said. Elevated headline inflation prints have already pushed household inflation expectations higher. Any sharp upward movement in rural wages remains a key trigger, according to the report.

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"Given the deeply negative output gap, firms will struggle with a lack of pricing power. With a recovery slowly emerging, producers may opt to pass on increases in input costs to retail consumers faster than anticipated. This could be an inflection point for the inflation-output trade-off, triggering action from the central bank," Barclays said in the report.

Lastly, continued elevated global commodity prices could create risks to financial stability, which could warrant some interest-rate defence of the currency. RBI has cut rates by 135 basis points since the pandemic hit the country and then left the rates unchanged for six consecutive policies.

Repo rate Unchanged At 5.15 percent

Reverse Repo Rate: 4.90 percent

MSF & Bank Rate: 5.40 percent

Repo Rate: Cut By 75 bps To 4.40 percent

Reverse Repo Rate: Reduced By 90 bps To 4 percent

MSF & Bank Rate: Reduced To 4.65 percent from 5.40 percent

Repo rate: Reduced By 40 bps To 4 percent

MSF & Bank Rate Reduced To 4.25 percent from 4.65 percent

Reverse Repo Rate: Reduced To 3.35 percent from 3.75 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent

Repo Rate: 4 percent

MSF & Bank Rate: 4.25 percent

Reverse Repo Rate: 3.35 percent