RBI holds rates again; normalisation may include measured tapering wrapped in RBI’s dovish rhetoric

While the overall tone and rhetoric around policy remains decisively dovish, wrapped up in this dovish packaging are a couple of potential surprises as well.

The MPC acknowledged the persistence of high core inflation as ‘an area of policy concern’, but has, for now, downplayed concerns around it. (Image: REUTERS)

By Churchil Bhatt

We have a status quo RBI policy, yet again. The MPC in the latest monetary policy meeting kept all rates unchanged and pledged to maintain its accommodative policy stance for as long as necessary. MPC also increased the quantum of existing VRRR (variable rate reverse repo) operations to Rs7.5 lakh crore by December end in a continuing effort to nudge the overnight rates higher towards repo rate. As per MPC, the economic recovery, even though gaining traction, is not conclusively durable and warrants further policy support. As a result, its ‘overarching priority’ for now is to broaden the growth impulses. The MPC regarded the uncertainty around the new Covid variant and the headwinds from faster normalization of monetary policy in advanced economies as the key risks to the domestic outlook. 

The MPC acknowledged the persistence of high core inflation as ‘an area of policy concern’, but has, for now, downplayed concerns around it. Even though the MPC propped up its 3QFY22 CPI forecast from 4.5% to 5.1%, it lowered its 4QFY22 CPI forecast from 5.8% to 5.7%. Hence, it expects the headline inflation readings to peak during 4QFY22 and then settle around 5% in FY23. It drew comfort from the recent excise duty cuts on petrol and diesel, supply-side interventions and the possibility of seasonal correction in vegetable prices with winter arrivals. Hence, while the Fed Chair Powel may have “retired” the word transitory, the inflation debate is yet to be settled in Indian context as per Dr. Patra, Dy Governor RBI.

While the overall tone and rhetoric around policy remains decisively dovish, wrapped up in this dovish packaging are a couple of potential surprises as well. Firstly, MPC’s forward inflation trajectory looks a little optimistic with most independent estimates of inflation around 20-30 bps higher compared to RBI’s projections for 2HFY22. Going forward, if inflation indeed surpasses RBI estimate, it may give MPC the ammunition to justify proportionate monetary tightening into FY23. Also, On the liquidity management front, RBI’s intent to make auction based VRRR the primary tool for liquidity absorption gives them the flexibility to make Repo Rate the operating overnight rate rather swiftly, amounting to a stealth rate hike, if required.

Omicron situation has meaningfully muddled the future outlook on world economy, in what looked like a post Covid era. Taking away policy support without appropriate guidance in such uncertain times can induce a lot of undue market volatility and in turn endanger economic recovery. In this period of so many unknown unknowns, predictability in the path of monetary policy is of immense support to economic sentiments. Hence, we expect the early part of post Covid policy normalization to be a cycle of measured tapering followed by gradual tightening, all sweetly wrapped in dovish rhetoric.

(Churchil Bhatt, EVP Debt Investments, Kotak Mahindra Life Insurance Company Limited. Views are the author’s own.)

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