RBI is still very dovish, but will inflation really remain low?

The February credit policy review of the Reserve Bank of India (RBI) would not have been considered to be critical under normal conditions. But with the Union Budget projecting borrowing of Rs 14.95 trillion for fiscal 2022-23 (FY23) and not giving clear guidance on inflation, the markets went into a tizzy with the 10-year bond increasing by over 20 basis points (bps).

Subsequently, there has been volatility in the market and the announcement made on Tuesday that the Friday auction has been called off after considering the cash balances of the government, the impression gotten is that this year's borrowing will probably be even lower than budgeted. This has assuaged the market for sure.

Let us see what the main issues were that were expected to be addressed in the policy. First was the view on GDP growth, as last time the monetary policy committee (MPC) of the RBI had felt that it was not yet durable. Here, the RBI takes a different view, where it believes that unlike the Budget 2022 assumption of higher growth of 8-8.5 per cent, the RBI is pitching for 7.8 per cent, which is in line with our estimates, which is 7.75-8 per cent. Therefore, the indication is that an accommodative stance will continue into the next year too, as long as inflation remains stable. The omicron effect, though less potent than the earlier waves, appears to still weigh on growth prospects. Therefore, this indicates that it is not yet time to turn attention to inflation, even in case it increases as the pandemic led non-durable growth objective takes precedence.

Second is the view on inflation for the year. Here, the RBI is very hopeful as it believes that inflation today is more due to base effects, which can be debated. The important take is that inflation will come down from 5.3 per cent in FY22 to 4.5 per cent in FY23, which also means that there is no reason to believe that inflation will increase. This is a fairly optimistic view given the state of the crude oil market, where Brent has been hovering around the $90 mark. We need to see the inflation number to change drastically for any further RBI action to be taken on interest rates.

Taken together, the RBI has spoken of an accommodative stance to prevail for an extended period of time as inflation comes down. An accommodative stance means that there are fewer possibilities of the repo rate being hiked which should be good news for the borrowers at a time when the private investment cycle will turn around.

Third, is the state of liquidity and move to normalisation. Here, the guidance is that there is no change in overall stance except operational issues in terms of how the repo and reverse repo auctions would be held. Liquidity management will now be through the 14-day term reverse repo, while the variable rate repo auctions would be used when required. Similarly, the timings for these windows have gone back to normal.

It is not surprising that bond yields have come down as such a dovish view was definitely not expected in the policy. Against this background, the decision to keep all rates unchanged is indicative not just of status quo today, but also lower probability of change in the coming year unless there is substantial change in the projections of GDP and inflation.

Madan Sabnavis is chief economist at Bank of Baroda and author of: Hits & Misses: The Indian Banking Story. The views expressed here are personal