Omicron scare may delay RBI plan to normalise accommodative monetary stance

The concern over the new Covid-19 variant Omicron may delay the Reserve Bank of India’s plan to normalise the extreme accommodative monetary stance, which could result in postponing a hike in the reverse repo rate to the February policy, if the scare turns out to be temporary.

The six-member monetary policy committee of the RBI will meet from December 6-8 to review the policy; the decision will be announced on the last day.

The GDP growth numbers for the second quarter that were announced earlier this week turned out to be higher than the central bank’s projection, made in the October policy review. As compared to the central bank’s projection of 7.9 per cent, GDP growth for the July-September period turned out to be 8.4 per cent - which would give the central bank confidence that growth revival was on track. This would have also made the central bank more confident to unwind some of the steps taken at the onset of the Coronavirus (Covid-19) pandemic. In particular, there was an expectation among economists that the central bank could hike the reverse repo rate, by at least 20 bps if not 40 bps, that would have fully or partially restored the policy corridor. (100 bps = 1 percentage point),

The policy corridor, that is the gap between the repo and the reverse repo rate, was widened from customary 25 bps to 65 bps after the Covid-19 pandemic hit the country in March 2020. A reduction in the policy corridor is seen as a step towards normalising the monetary policy stance.

“While the Q2 GDP was better and H2 FY22 inflationary pressures are likely to be higher than RBI’s projection, the uncertainty caused by the new variant-Omicron, probably will keep the MPC on a slightly cautious footing,” said Anubhuti Sahay, head of economic research, South Asia, Standard Chartered Bank.

First two cases of the Omicron variant were detected in India on Thursday. First detected in South Africa last month, the new variant has been declared as ‘Variant of Concern’ by the World Health Organisation though it is yet to be established whether the variant is more transmissible.

“While any direct guidance on rate normalisation might not be forthcoming, MPC is likely to stay data dependent giving them the optionally to act on reverse repo rate in February 2022, if the variant is non disruptive,” Sahay told Business Standard.

“With growth on a strong footing, the RBI is inching towards withdrawal of its extra-accommodative policies. But with concerns emerging around a new COVID variant, we think the central bank is likely to guide for a very gradual path of policy normalization,” said Rahul Bajoria, chief India economist, Barclays.

Sticky core inflation

Even if the central bank decides to delay further policy normalisation, it may not take the eye off inflationary pressures, analysts said. Inflationary pressures are likely to stay despite the centre, and some of the states cutting taxes on petrol and diesel.

“Focus on inflationary pressure is unlikely to dilute especially given sticky core inflation,” Sahay said.

During the last monetary policy review meeting, RBI reduced the inflation forecast for the full year sharply – from 5.7 per cent to 5.3 per cent, while retaining GDP growth at 9.5 per cent.

Retail inflation, measured by the Consumer Price Index (CPI), rose to 4.48% in October, due to an uptick in food prices. The CPI-based inflation in September 2021 was at 4.35 per cent and in October 2020 it was 7.61 per cent.  

“Despite the large cuts in fuel taxes, inflation remains a cause of concern. While food price volatility will push near-term inflation higher, we expect the central bank’s focus to remain on the medium-term price outlook, particularly on the likely return of pricing power, as rising input costs across core goods and services warrant caution,” Bajoria said.

Data dependent guidance

Since the onset of the Covid-19 pandemic, the RBI has clearly prioritised growth revival as it promised to maintain the accommodative stance till growth revives on a sustainable basis. However, in the last meeting of the Monetary Policy Committee (MPC), three out of six members emphasized the need for the guidance to be data dependent.

Jayanth Varma, the only member who voted for a change in stance to neutral, was of the opinion that the MPC needs to remain data driven so that it can respond rapidly and adequately to any unforeseen shocks that may arise in future.

Another external member Ashima Goyal also backed data-based policy as she thinks inflation may fall faster than guidance, or supply-side issues may cause new spikes.

“How do we frame monetary policy against the backdrop of the emerging new challenges? First and foremost, we need to remain data dependent,” internal member Mridul K Saggar had said.

Before the Covid-19 pandemic RBI had a data driven guidance policy, but since the onset of the pandemic, the priority has been to support growth, irrespective of the inflation numbers.

RBI governor Shaktikanta Das, however, argued for a ‘well-telegraphed action to avoid any surprise. “At this critical juncture, our actions have to be gradual, calibrated, well-timed and well-telegraphed to avoid any undue surprises,” Das said as the MPC minutes showed.

Economists also said there is a possibility that the central bank will restart data dependence guidance.

“With regard to policy implications, besides maintaining its growth projection, the central bank is likely to underscore its preference to be data-dependent with regard to the policy direction, even as the likelihood of a measured increase in the reverse repo rate in December remains on the table,” Radhika Rao, senior economist, DBS Bank in a note.