RBI Monetary Policy: Did The Central Bank Delay Normalisation Or Tighten By Stealth?

A more dovish-than-expected monetary policy might indicate a longer road to normalisation.

<div class="paragraphs"><p>An escalator on a newly built section of Grand Central Terminal in New York, U.S., on Thursday, May 27, 2021. This is the largest new train terminal to be built in the United States since the 1950s. Photographer: Angus Mordant/Bloomberg</p></div>
An escalator on a newly built section of Grand Central Terminal in New York, U.S., on Thursday, May 27, 2021. This is the largest new train terminal to be built in the United States since the 1950s. Photographer: Angus Mordant/Bloomberg

India's Monetary Policy Committee voted to keep the benchmark repo rate unchanged, while the central bank maintained status quo on another key rate—the reverse repo rate.

The monetary policy stance remained accommodative and the central bank gave no signal that a reversal of ultra-easy monetary policy is inching closer. This, despite the fact that risks to inflation are seen to be on the upside.

While acknowledging the central role of price stability in monetary policy, RBI Governor Shaktikanta Das focused heavily on growth. "Managing a durable, strong and inclusive recovery is our mission," said Das.

How are economists interpreting the signals from the central bank?

Rate Hikes Pushed Further Away?

While a subtle shift has been brought in with the comment that price stability remains the cardinal principle of monetary policy, the overarching tone of today's statement and forward guidance is less hawkish than anticipated, said Aditi Nayar, chief economist at ICRA.

The comment on managing a durable, strong, as well as inclusive recovery, underscores concerns of a K-shaped trend underpinning the traction in economic growth.

With the MPC remarking that the ongoing domestic recovery needs sustained policy support to make it more broad-based, we now foresee a slightly lower likelihood of our base case assessment that the stance will be changed to neutral in the February 2022 policy review.
Aditi Nayar, Chief Economist, ICRA

While there was a partial likelihood of a modest hike in reverse repo rate in today's MPC policy meeting, the central bank has stuck to its principle of ‘gradualism’ since the downside risks to a durable growth trajectory have clearly increased due to the spread of a new Covid variant, said Suman Chowdhury, chief analytical officer, Acuité Ratings & Research.

Interestingly, there has been no guidance on the rate trajectory, even on the reverse repo front. This makes it difficult to predict the next steps in terms of bond yields, he said.

Pause In Normalisation

The RBI today paused the normalisation process that began in October and indicated it will maintain a growth-centric normalisation of policy, said Rahul Bajoria, chief economist at Barclays. He had expected a 20-basis-point increase in the reverse repo rate. However, the resilience of economic activity will keep the RBI on track to normalise its policy conditions in 2022, he said.

If risks to growth from Covid-19 dissipate, the RBI will provide a calibrated path towards policy normalisation and normalise the policy corridor at the next meeting in February, Bajoria said.

Our forecast of repo rate hikes in Q2 and Q3 2022 (April and September quarter) remains on track, given that inflation is likely to stay above 5% over the forecast horizon.
Rahul Bajoria, Chief Economist, Barclays

Stealth Normalisation?

Some economists, however, believe that stealth normalisation has continued.

The RBI has said that they are going to move most liquidity absorption to the auction-based route in January, said Kaushik Das, chief India economist at Deutsche Bank. This means that most liquidity will now be absorbed a rate well above the reverse repo rate of 3.35% and closer to the repo rate of 4%, Das explained.

Over the past few months, the cut-off rate at variable rate reverse repo auctions has moved to near 4%.

In my view, the RBI has delivered a stealth tightening. By January, we will see that all the short term rates are already adjusting closer to the 4% repo rate mark. Even if the reverse repo is at 3.35%, it becomes completely meaningless.
Kaushik Das, Chief Economist, Deutsche bank.

All Eyes On Omicron

The whole premise of calling for a 20 basis points hike in December was that the groundwork was already done between the October and the December policy, said Vivek Kumar, economist at QuantEco research. The money market rates had already started moving up, Kumar also explained. A reverse repo move in the December policy would have largely been symbolic move, catching up with where the money market rates are currently.

"The fact that the RBI chose not to do it, shows that the RBI is giving far more importance to omicron risks despite sounding fairly confident on the growth recovery prospects, despite raising a little bit of alarm on inflation and despite highlighting what other central banks are doing. They had so many reasons to start the official normalisation process and just one reason to wait. The RBI still chose that one reason to wait."

If the RBI is looking at uncertainty and if this uncertainty continues to persist in February, things will not be clear as they are now, Kumar said.

Wait And Watch Mode

Absorption of a higher quantum of liquidity through variable rate reverse repo operations signals the RBI's intent to continue with liquidity normalisation and be opportunistic about policy and liquidity normalisation, said Suvodeep Rakshit, senior economist at Kotak Institutional Equities.

Short-term rates have adjusted higher and will possibly continue to inch closer to the repo rate over the next few months.

Further, from January 2022, the RBI while shifting liquidity management to the auction route has refrained from committing to any tenor. "We expect the RBI to focus on shorter tenor (closer to overnight) auctions such that the weighted average call rate moves closer to the repo rate providing adequate signal to the market of policy normalisation in the February policy."

If the Omicron variant turns out to be benign, the RBI will look at reverse repo rate hike of 20 basis points in the February policy and more aggressive liquidity normalisation tools in Q4 FY22.
Suvodeep Rakshit, Senior Economist, Kotak Institutional Equities

Downplaying Inflation?

On the face of it, the RBI’s macro view of the economy remains largely unchanged—the underlying message still remains one of growth gaining traction, but in need of policy support, while inflation remains under control, with the rise in the next quarter largely a consequence of base effect, said Aurodeep Nandi, India economist and vice president at Nomura.

This somewhat downplays the inherent upside risks on inflation, especially with firms across various sectors starting to raise their prices amid potential demand-side pressures that would start to build up as the output gap closes.
Aurodeep Nandi, India Economist & Vice President, Nomura

On the forward outlook, while the RBI is likely to continue remaining behind the curve for now, upside risks on inflation make an inflection in monetary policy trajectory inevitable, Nandi said, anticipating 100 basis points in policy rate hikes in 2022.

Watch a conversation of the implications of the monetary policy review below: