RBI policy-driven euphoria to be short-lived, D-St to take cues from Q3 results, state polls

Reserve Bank’s Monetary Policy Committee (MPC) decided to keep key rates unchanged at its meet on Feb 08-10 and maintained an accommodative policy stance. The outcome was more dovish than most economists expected.

However, the operating effective reverse repo rate – the weighted average rate of the fixed rate reverse repo and the VRRRs of longer maturity – increased from 3.37% as at End-August 2021 to 3.87% as on February 4, 2022. Reading the fine-print of minutes of this MPC’s meeting would provide more insights into the MPC’s mind for not narrowing the policy corridor between repo rate and the reverse repo rate.

Though the intent of the RBI to support the recovery in the economy in the face of disruption due to the Omicron variant of Coronavirus is commendable, economists will now fear whether the RBI will fall behind the curve, having maintained the easy monetary stance longer than most other central banks had.

The RBI has projected 4.5% CPI in FY23 (vs 5.3% for FY22), with CPI expected to fall sustainably below 5% in Q3FY23. One hopes that the inflation trajectory will soon come under control and the bet of the RBI pays off.

The MPC noted that consumer price inflation has edged higher since its last meeting, but largely along anticipated lines. The increase in inflation in December was entirely due to unfavourable base effects despite month-on-month decline in prices. Core inflation remains elevated and sticky, mainly driven by transport and communication while demand pull pressures are still muted. The renewed surge in crude oil prices and pass-through from WPI inflation remains a key upside risk.

Quarterly GDP growth projections remain volatile due to base effect with 4.5% growth projected for Q4FY23 compared to 7.8% for the whole of FY23. The MPC continued with its pro-growth support commentary. The RBI noted that output is just barely above its pre-pandemic level, while private consumption is still lagging.

Global headwinds are accentuating. The surveys done by the RBI reveal that capacity utilisation is rising, and the outlook on business and consumer confidence remains in optimistic territory, which should support investment as well as consumption demand. The prospects for agriculture have brightened on good progress of winter crop sowing.

The policy statement highlighted its commitment to do whatever it takes to ensure financial stability and insulate domestic financial markets from global spillovers; while ensuring calibrated sustainable recovery and price stability. The market was expecting some announcement/action to tackle the huge borrowing programme of Rs 14.95 trillion in the next fiscal, given that the timing of sovereign bond inclusion in global index is uncertain. Perhaps an announcement on this front would be expected in the April meeting, at a time when H1FY23 borrowing calendar is released.

Equity markets may temporarily welcome this decision, but will be largely driven by the balance Q3 corporate results, outcome of state elections and changes in global risk appetite. As far as bond markets are concerned, bond prices could soon after rising today, fall and bond yields start to rise as the specter of large borrowings over FY23 looms large.