Committed to growth, RBI maintains accommodative stance

Just when we thought that the economy (and life in general!) was beginning to take some semblance of normalcy, the second wave of COVID has once again underlined the capricious nature of recovery. Against this backdrop, the RBI’s MPC expectedly maintained a status quo on rates and committed to remain accommodative with an open-ended guidance of “as long as necessary to sustain growth on a sustainable basis”.

At the beginning of 2020, we had alluded to India’s V-shaped recovery in FY22 being a function of 2 other V’s i.e. vaccination and virus. And rightly so, a quarter later while a better-than-anticipated progress has been made on the vaccine front, unfortunately, the virus, too, has to made a strong comeback.

In comparison to Q1 FY21, the impact of containment measures on growth is expected to be far limited, as 1) businesses and consumers have learned to live with the virus, 2) lockdowns are less stringent and less pervasive and 3) vaccine programme continues to make significant headway.

Consequently, we continue to retain our (which is our best-case scenario) FY22 GDP growth estimate at +11.5%, led by vengeance demand, especially in services (backloaded in FY22), continued recovery in manufacturing, a supportive global backdrop amidst a favourable base at play. At the other end of the spectrum (our worst-case scenario), a possibility of poor control of virus and vaccine taking greater time to achieve critical mass could induce a slower growth of 8.0% in FY22 – almost equal in magnitude by which it contracted in FY21.

As such, it came as no surprise that the RBI chose to retain its FY22 growth estimate at 10.5%, which was in any case more conservative compared to the range of market forecasts.

On inflation, as per the last two readings since the last MPC meeting in February 2021, trajectory has clearly bottomed out. Nevertheless, headline inflation remains within RBI’s comfort as reinforced by RBI’s downward revision of Q4 FY21 average to 5.0% (vs 5.2% earlier). Looking ahead, while headline inflation could remain somewhat sticky in FY22 as economic recovery gains ground, it is expected to be lower vis-à-vis FY21. Upside from crude oil prices could be offset by a likely hold/reduction in duties on petroleum products, softening of demand due to a resurgence in Covid infections, and likelihood of a normal monsoon outturn (as per private weather forecasting firm AccuWeather) in 2021. For FY22, the RBI’s quarterly estimates point to an average inflation of 5.0% – which is line with our expectations, compared to 6.2% in FY21.

Some quarters of the markets were expecting the RBI to further delay its normalisation of rates and liquidity. We, however, believe that a failure to gradually normalise now will imply harder adjustments required in future that can be disruptive (read mid-2022 Fed taper most likely). In this spirit, the RBI signalled its intent to gradually normalise liquidity, which currently stands close to 4% of NDTL of banks compared to 2.3% as of end-Mar 2020. We expect the RBI to guide liquidity surplus to 2.0-2.5% of NDTL by end-March 22, thereby reducing the glut while also ensuring ample liquidity remains in the system.

The central bank also gave comfort to bond vigilantes by committing to buy G-Secs in the secondary market to the tune of Rs 1 lakh crore in Q1FY22 via a newly mooted tool of G-Sec Acquisition Programme — GSAP 1.0. This would be critical for a smooth completion of the elevated borrowing requirements from the central and state governments in FY22, along with an orderly evolution of the
yield curve.

(Shubhada Rao is the founder of QuantEco Research; Yuvika Singhal and Vivek Kumar are economists with QuantEco)