Whatever it takes: But for how long?

In its August 2021 policy review, the Monetary Policy Committee (MPC) maintained a status quo on the policy rate and the accommodative stance. It reiterated its support towards the nascent economic recovery, which was expected in light of the persisting uncertainty, growing concerns regarding the Delta variant and only gradual rise in the domestic vaccination levels. Nevertheless, the disquiet generated by the last two CPI inflation prints that had breached the 6-per cent threshold, led to a sharp upward revision in the FY22 inflation forecast. 

The culmination of the tussle between balancing growth and inflation considerations, was the non-unanimous outcome of the vote to continue with the accommodative stance. With this chink in unanimity, markets will remain on edge regarding how the votes will stack up in the next two policy reviews.

The CPI inflation had averaged 5.6 per cent in Q1FY22, exceeding the MPC’s June forecast of 5.2 per cent, which the Committee has assessed was largely driven by adverse supply shocks that are likely to be transitory.

As foreseen, the MPC has sharply upped its forecast for the FY22 CPI inflation rate to 5.7 per cent from 5.1 per cent, with risks broadly balanced. Its new quarterly projections entail an upward revision of 50-60 bps each in the remaining three quarters of FY22.

The Committee has projected the CPI inflation rate at an unnerving 5.9 per cent in Q2FY22, practically at the upper threshold of its medium-term target. A subsequent base-effect led cooling to 5.3 per cent in Q3, but is expected to reverse to 5.8 per cent in Q4, presumably as producers get emboldened to push through price hikes, once widening vaccine coverage strengthens domestic demand.

While inflation is subsequently expected to ease to 5.1 per cent in Q1FY23, this remains well above the 4 per cent mid-point of the target range.

At the same time, the forecast for the real GDP expansion in FY22 has been retained at 9.5 per cent. However, the quarterly projections have been modified, with an upward revision in the Q1 estimate. This has been offset by weaker projections for the subsequent three quarters, suggesting less back-ending of pent-up demand.

The Governor clearly stated that the RBI remains in ‘whatever it takes’ mode, referring to the desire to support the fledgling recovery. At the same time, the MPC resolution explicitly stated that the Committee is conscious of its objective of anchoring inflationary expectations. In our view, as domestic demand strengthens and starts dominating inflationary pressures in place of the current culprit of runaway commodity prices and supply constraints, the MPC will have to shift gears to prevent inflation expectations from unhinging.

We anticipate a change in the stance to neutral in the February 2022 policy review, followed by a hike in the repo rate of 25 bps each in the April 2022 and June 2022 reviews. If inflation springs a negative surprise, the stance change may well be advanced to the December 2021 review, with a lift-off in rates starting as early as February 2022. 

The author is chief economist at ICRA