While the macro backdrop got further complicated in recent months, RBI’s contra-cyclical policy resolve appears strong
By Siddhartha Sanyal
The status quo on policy rates with unanimous voting and continued “accommodative” policy stance was on expected lines. While the split voting on the monetary policy stance was a modest surprise, RBI clearly remains committed to continue supporting growth, given the nascent and uneven nature of recovery. The MPC looks set to keep the key policy rates unchanged in the near future. One expects them to maintain status quo on the repo rate at least during the remaining months of 2021-22, if not longer.
While RBI has reaffirmed its FY22 GDP growth forecast of 9.5%, the quarterly path of growth projections remains an interesting one. The central bank has revised its GDP growth forecast for Q1 FY22 upwards by nearly 300 basis points (bps), while forecasts for each of the three subsequent quarters have been revised lower by 50-90 bps from the levels projected earlier. Thus, policymakers are more confident of the Q1 growth print, based on high frequency data and statistical effects of a markedly favourable base. However, they are cautious about growth expectations in the coming quarters.
Importantly, RBI projects a low 6% GDP growth during the second half of the current financial year, despite a meagre 1.1% growth during the second half of FY21. This, once again, underscores the heavy statistical effects (of about 16% GDP contraction in H1 FY21) behind a likely high growth print during the first half of FY22.
Indeed, the harsh second Covid wave has implications for medium-term business and consumer confidence. RBI’s own surveys suggest that urban consumer confidence reached a multi-year low during the first wave of Covid-19 about a year back and barely improved since then. Household sentiment suffered a stronger beating in the rural areas during the second wave. Thus, once the base-effect-related disruption fades, one can expect only modest recovery in real private consumption demand, which typically constitutes two-third of India’s GDP. Overall, we see material downside risks to RBI’s GDP growth forecasts.
Given a stronger global recovery, uptick in commodity prices, sticky food inflation and rise in domestic fuel prices, inflation may stay too high for RBI’s comfort. CPI averaged 5.7% in Q1 and is projected at 5.9% in Q2. While RBI’s CPI forecasts are higher than street expectations, their assessment of balanced risks to this forecast of 5.7% for FY22 does not rule out further upside.
Nevertheless, despite meaningful threats of CPI inflation prints crossing the central bank’s “upper tolerance band” in coming months, one feels that it was most appropriate that the MPC conveyed their bias to look through the same and continue supporting growth recovery, especially given the dominance of supply-side factors in fanning inflation of late. This remains consistent with the agility that the central bank demonstrated in using both conventional and unconventional monetary policy tools since the outbreak of the pandemic in March 2020.
Several unconventional policy initiatives in recent times attempted increasing the flow of liquidity to small businesses and MSMEs. Against that backdrop, extension of the “On-Tap TLTRO” window, relaxation in MSF financing for another three months, and extending the deadline for achieving the financial parameters under the resolution framework for Covid-related stress by another six months are welcome steps in the context of reviving small businesses and stressed entities.
Ensuring stability and smooth functioning in financial markets had been one of the priorities for RBI throughout the pandemic. Along with OMOs and Operation Twist, stepping up of G-SAP and inclusion of SDLs in the same had helped cushion bond yields amid risks of larger borrowings and generally heightened uncertainty. While the additional quantum of Variable Reverse Repo Rate auctions may trigger some knee-jerk reaction, one expects BI to stay cautious and non-disruptive. Overall, while the macro backdrop got further complicated in recent months, RBI’s contra-cyclical policy resolve appears strong. As recovery still stays tentative and uneven, it is important for policymakers to continue supporting growth and to keep focusing on policy initiatives towards better credit flow, including to MSMEs, smaller businesses and stressed sectors, likely relying more on unconventional tools.
The author is Chief economist & head of research, Bandhan Bank
Views are personal