RBI policy: No explicit time frame for continuation of accommodative stance

The monetary policy stance is expected to remain accommodative for most of 2021, until a dramatic improvement in vaccine coverage quells uncertainty regarding the growth outlook

With restrictions and uncertainty continuing amidst the second wave of Covid-19, the Monetary Policy Committee (MPC) has predictably maintained status quo on the policy rates and stance, while tweaking its growth-inflation forecasts.

The Committee has kept the repo rate unchanged at 4 per cent in its second policy review for FY22, in line with the primary mandate of ensuring that the CPI inflation remains within a band of 2-6 per cent, while supporting growth. It has also decided to maintain the accommodative stance, for as long as necessary to durably revive and sustain growth and mitigate the economic impact of the pandemic, while ensuring the CPI inflation remains within the target.

The MPC has now projected the CPI inflation to average 5.1 per cent in FY22, with risks characterised as broadly balanced. It has maintained its forecast of 5.2 per cent for Q1FY22, and mildly raised the projections for Q2FY22 (to 5.4 per cent from 5.2 per cent), Q3FY22 (to 4.7 per cent from 4.4 per cent) and Q4FY22 (to 5.3 per cent from 5.1 per cent). 

Moreover, the MPC has pared its forecast for the real GDP expansion in FY22 to 9.5 per cent from the 10.5 per cent it foresaw before the second Covid surge had taken hold. However, there is a divergence in direction of the revision for the two halves of this fiscal. The quarterly projections have been cut for Q1FY22 (to 18.5 per cent from 26.2 per cent) and Q2FY22 (to 7.9 per cent from 8.3 per cent). Simultaneously, the Committee has upped its forecasts for Q3FY22 (to 7.2 per cent from 5.4 per cent) in Q4FY22 (to 6.6 per cent from 6.2 per cent).  

Overall, the MPC's real GDP growth projection of 9.5 per cent is in line with the upper end of our own forecast range of 8-9.5 per cent. We believe that accelerated vaccine availability, resulting in a back-ended surge in domestic demand, is central to this outcome, as suggested by the upward revision in the Committee’s growth expectations for H2FY22. Moreover, continued global growth, resulting in a recovery in the export-oriented sectors, would be a prerequisite for Indian GDP growth to be as high as 9.5 per cent in FY22.

However, the awaited resurgence in domestic demand may test the belief that weak pricing power will prevent the transmission of the vaccine optimism-fuelled rally in global commodity prices to domestic retail prices. Accordingly, a real GDP growth of 9.5 per cent may be somewhat inconsistent with an average CPI inflation of 5.1 per cent in FY22, unless taxes on fuels undergo an appreciable reduction.

In our view, the MPC is firmly focussed on nurturing a durable revival in economic growth amidst the prevailing uncertainty. We anticipate that it will demonstrate a high tolerance for the average CPI inflation to range between 5-6 per cent during the recovery period, and therefore do not foresee a hike in the reverse repo or the repo rate during 2021. Moreover, we expect the monetary policy stance to remain accommodative for most of 2021, until a dramatic improvement in vaccine coverage quells uncertainty regarding the growth outlook.

Additionally, the RBI is likely to maintain its focus both on yield curve management, as well as the ample and equitable distribution of liquidity as India battles the Covid crisis.

The provision of on-tap liquidity for contact intensive sectors, additional funds for SIDBI and the enhancement in the exposure levels to Rs. 50 crore for the Resolution Framework 2.0 by the RBI are all welcome, given the presence of several smaller and less formal entities, which have been disproportionately affected by the pandemic.

Managing the yield curve is important for market stability and to enable borrowers to make the choice of appropriate maturity. There were two important announcements on the Government-security acquisition programme (G-SAP) front. State Development Loans (SDL) of Rs 10,000 crore are being included for the first time in the last tranche of the GSAP 1.0 auction of Rs 40,000 crore. This is likely to temporarily moderate the 10-year G-sec-SDL spread below the prevailing 80 bps.

Nevertheless, a sustenance of lower spreads may require continued purchases of SDL by the Central Bank through G-SAP or regular open market operations. 

Further, G-SAP 2.0 was announced for an amount of Rs 1.2 trillion, which happens to be lower than the back-to-back loan of Rs 1.58 trillion that has been announced recently to cover a portion of the GST compensation requirement of the states for FY22. 

Fundamental factors such as the need for fiscal support amidst already high sovereign borrowings, and hardening prices of crude oil are likely to episodically make the bond markets nervous. As a result, cancellations and devolvements may continue in the weekly G-sec auctions, especially with 6 per cent likely to remain the Central Bank's desired cap for the 10-year G-sec.   

Aditi Nayar is chief economist at ICRA. Views are her own.