By Aditi Nayar

With an uneven albeit strengthening domestic recovery—amidst continuing concerns on non-food inflation—the Monetary Policy Committee (MPC) maintained the repo rate unanimously at 4%, and the monetary policy stance as accommodative (with a vote of 5:1), in its October 2021 meeting. It also retained its FY22 growth forecast at 9.5%, while reducing inflation forecast by 40 bps.

Moreover, RBI left the reverse repo rate unchanged at 3.35%, in spite of the recent higher cut-offs in the variable rate reverse repo (VRRR) auctions. It did, however, move towards liquidity normalisation with a calendar for 14-day VRRR auctions, and a pause in the government-securities acquisition programme (G-sap) following the lower-than-expected market borrowing calendar for the Government of India (GoI). Overall, there were no surprises provided by either the MPC or RBI.

The MPC cut its inflation projection for FY22 to 5.3% from its August 2021 forecast of 5.7%, with risks broadly balanced, led by the benign outlook for most food prices. Nevertheless, it did raise concerns related to rising prices of edible oils, fuels and metals, input shortages and high logistics costs. Moreover, it called for calibrated cuts in indirect taxes on petrol and diesel by both the Centre and the states, as a tool to achieve durable reduction in inflation and aid the anchoring of inflation expectations.

We believe the CPI inflation cooled to 4.8% in September 2021, dampened by a fall in food inflation. The favourable base is likely to further ease inflation in October-November 2021, even as fuel and core pressures are expected to strengthen, with the revival in domestic demand around the festive season likely to regenerate pricing power. In addition to higher prices of crude oil, the prevailing coal shortage is expected to bloat the costs of power and various industrial inputs, posing a threat to the inflation outlook. Consequently, we have scaled down our CPI inflation forecast for FY22 by only 20 bps, to 5.3-5.5% from 5.5-5.7%.

Q1FY22 GDP growth had modestly trailed the MPC’s projection of 21.4%. However, the MPC has maintained its expectation of a 9.5% GDP expansion in FY22, raising its forecasts for Q2FY22 (to 7.9% from 7.3%) and Q3FY22 (to 6.8% from 6.3%), with its Q4FY22 growth projection remaining unchanged (at 6.1%).

Encouragingly, the volumes of six of the 10 high frequency indicators rose above their pre-Covid levels in Q2 FY2022, including petrol consumption (estimated by ICRA), electricity demand, rail freight, output of Coal India Limited, GST e-way bills and non-oil exports. On the other hand, the volumes of domestic airline passenger traffic, vehicle registrations, diesel consumption (estimated by ICRA) and ports cargo traffic continued to trail the pre-Covid levels. We expect the real GDP in Q2FY22 to report a growth of 7.7%, mildly lower than the MPC’s 7.9% forecast, with absolute GDP expected to be slightly lower than the pre-Covid level.

The widening coverage of Covid-19 vaccines is likely to boost households’ and businesses’ confidence further. Moreover, it will reinvigorate the demand for contact-intensive services, helping revive the sectors most affected by the pandemic Additionally, the expected acceleration in Union spending after the withdrawal of the earlier cash management guidelines will boost activity as well as confidence levels. Moreover, the assessment of a robust kharif harvest is likely to sustain the consumption demand from the farm sector. Accordingly, we expect the GDP to exceed the pre-Covid level in H2FY22, with our full year growth forecast placed at 9.0% for this fiscal.

The MPC’s comment that the recovery is uneven and critically dependent upon policy support, rules out an early repo rate hike or stance change. Moreover, a reverse repo rate hike by RBI in December 2021 remains uncertain as of now. We anticipate that the stance of monetary policy will be changed to neutral from accommodative only after there is abundant evidence that the economic recovery can sustain without policy support. This appears likely in the MPC’s February 2022 policy review, to be followed by a hike in the repo rate of 25 bps each in the April 2022 and June 2022 meetings.

With a status quo on rates amidst a pause in the GSAP programme, surging crude oil prices and imminent bond tapering by the US Federal Reserve, the 10-year G-sec yield jumped to a close of 6.32% on Friday. It is expected to range between 6.25-6.4% in Q3FY22. A sustained dip below 6.25% is only expected if RBI indicates considerable OMO purchases in the 10-year bucket, and crude oil prices cool to under $70/barrel, both of which seem rather unlikely.

The author is Chief economist, ICRA