We expect the accommodative monetary policy stance to remain unchanged not only in the upcoming April policy, but at least till the June policy
RBI heads into the April monetary policy (decision to be announced on April 7) under a considerably uncertain and volatile macro backdrop, both globally and locally. Post the February 2021 monetary policy, US interest rates have continued to sell off quite aggressively (thereby having a knock-on impact on Indian bond yields as well), while global oil prices have also exhibited considerable amount of volatility, with Brent currently being 20-25% higher than end-December 2020 levels. And at home, new Covid-19 cases have increased rapidly since early-February, raising questions about the downside risks to growth.
Against this backdrop, we expect the overall monetary policy statement to be as neutral as possible, with growth risks due to rising Covid-19 cases being offset by the perceived uncertainty regarding the medium-term inflation outlook, from potential higher oil prices and persistence of sticky core inflation momentum. Although the current flexible inflation targeting framework with 4% mid-point CPI target (within +/-2% band) has been maintained in its entirety for the next five years, without adding core inflation as a second additional determinant for deciding on monetary policy stance, we think in reality the MPC members will put a lot of emphasis on the evolving core inflation trend (as they have been doing in the past as well) to inform their monetary policy decisions in the future.
—Monetary policy stance: We expect the accommodative monetary policy stance to remain unchanged not only in the upcoming April policy, but at least till the June policy, given the uncertainty posed by the sharp increase in Covid-19 cases within the country, which could slow down the pace of the current growth recovery, if localised lockdowns become more broad-based in the April-June 2021 quarter. We expect the MPC to maintain the guidance from the previous policy stating that “continued policy support is crucial, till the prospects of a sustained recovery are well secured while closely monitoring the evolving outlook for inflation.” We are not sure whether the MPC will state categorically that it is ready to maintain the accommodative monetary stance at least till 1HFY22 (till end-September 2021), but this may become a possibility, if the members assess the growth risks due to the second wave of Covid-19 to be higher compared to inflation risks over the next six months.
—Liquidity operations: As far as liquidity operations are concerned, we expect RBI to reiterate that surplus liquidity will remain ample to support growth and that the space created by CRR reversal will be offset by OMO purchases of bonds to help bridge the gap between demand-supply of bonds and prevent longer-end bond yields from shooting up excessively in a short period of time. While we still expect the reverse repo rate to be hiked two times (in clips of 20bps each) in the second half of 2021 (either in August/December or October/December), to 3.75% by the end of the year (from the current rate of 3.35%), we don’t think RBI will give any indication regarding that in the upcoming policy.
—Soft yield curve control: We expect the monetary policy statement to reiterate that RBI will buy at least Rs 3 trillion of government bonds in FY22 to provide support to the bond market and to ensure that financial market conditions remain accommodative, in line with the broader accommodative monetary policy stance, but we don’t see RBI providing an OMO calendar in advance. The government has announced its decision to borrow Rs 7.24 trillion in 1HFY22 (which is about 60% of the total gross market borrowing requirement of Rs 12 trillion for FY22), and now the market participants would wait eagerly to see how much RBI will want to buy in 1H of FY22 out of the Rs 3 trillion total buying that is expected from the central bank in FY22.
—Growth and inflation forecasts: We expect RBI to revise its average inflation forecast downward for January-March 2021 to 4.8-4.9% (from 5.2% earlier), while maintaining the April-June 2021, July-September 2021 and October-December 2021 forecasts at 5.2%, 5.0% and 4.3%, respectively. RBI, in our view, has already taken a conservative forecast for CPI inflation in 1HFY22 and, therefore, we do not see any need to adjust the forecast higher at this stage. In fact, our own CPI inflation forecast (quarterly average) for April-June 2021 and July-September 2021 are slightly lower at 4.7% and 4.6%, respectively, with the October-December 2021 CPI average being similar to that of RBI’s (4.3%). We expect the MPC to highlight potential upside risks to CPI inflation from rising oil prices (though the mark-to-marketing of higher global oil prices has already occurred when Brent rose close to $70/barrel) and sticky core inflation momentum, but we don’t see any need for RBI to change its forecast at this stage.
We do not expect the central bank to change its growth forecast for FY22 (+10.5% y-o-y real GDP growth) at this stage, despite rising Covid-19 cases, as RBI’s forecast, which is exactly similar to our own growth forecast, is already conservative and builds in various potential risk factors. The latest February fiscal data reveal that total expenditure has increased by 52.9% y-o-y after rising 49.5% y-o-y in January. The expenditure momentum will remain strong in April-June 2021 as well, unlike in the last year when India went into a nationwide lockdown. The latest BOP data also show that India’s current account balance has already turned into a small deficit in October-December 2020 ($1.7 billion; 0.2% of GDP), which will continue to widen steadily in the next several quarters. Therefore, despite the rising Covid-19 cases, we think April-June 2021 real GDP growth will be about 25.5% y-o-y (RBI’s forecast is 26.2% y-o-y), which should lead to an overall real GDP growth of 10.5% y-o-y in FY22.
The author is India Chief Economist, Deutsche Bank AG