RBI doesn’t hike policy rates, roots for durable broad-based economic recovery

The RBI kept the repo rate — the rate at which the RBI lends to banks — unchanged for the tenth time in a row at 4 per cent. All six members of the MPC, headed by RBI Governor Shaktikanta Das, voted to keep the repo rate intact while one member, Jayanth Varma, dissented against retaining the accommodative policy stance. The RBI decision indicates that lending and deposit rates are expected to remain unchanged in the banking system.

What surprised most economists and market participants was the central bank retaining the reverse repo rate at 3.35 percent. The reverse repo rate is the rate at which RBI borrows from banks. A hike in this rate would have meant that the central bank wanted to absorb more money, or liquidity, from the banking system and would have signalled the start of the reversal of the monetary policy cycle that would eventually lead to a rise in rates.

Behind the RBI decision not to hike rates is also its outlook on inflation for the next financial year. Despite crude oil prices rising over $90 per barrel, it has projected a lower retail inflation level of 4.5 per cent in the next fiscal 2022-23 as against the inflation forecast of 5.3 per cent for 2021-22.

However, the MPC has decided that growth needs to be supported. The MPC is of the “view that continued policy support is warranted for a durable and broad-based recovery,” Das said.

Expressing optimism, Das said, “as Lata Mangeshkar – whom we lost recently – sang in her immortal voice: aaj phir jeene ki tamanna hai. Together with the spirit behind the next line of this beautiful song, she has conveyed an eternal message of optimism.”

Das said the ability to forecast the future course of the economy is so contingent on the evolution of the virus that one prognosis is as good or as bad as the other and as ephemeral. “If the last two years of living with the virus have taught us anything, it is to remain humble, but grounded in self-belief, never losing confidence and optimism,” he said.

Globally, central banks have been tightening the monetary policy to control inflation. In the US, Federal Reserve Chairman Jerome Powell signalled last week that the US central bank would begin steadily raising interest rates in mid-March. The Bank of England raised interest rates to 0.5 per cent. In Brazil, the central bank recently increased its benchmark interest rate by 1.5 percentage points to 10.75 per cent and signalled another increase at its next meeting. The European Central Bank kept its key interest rates unchanged, but it left the door open to an interest-rate increase later this year.

The RBI has projected real (adjusted for inflation) gross domestic product (GDP) growth projection at 7.8 per cent for 2022-23. The real GDP growth at 9.2 per cent for 2021-22 takes it modestly above the level of GDP in 2019-20, the policy panel said. But the projection is marginally below the lower limit of the band of 8-8.5 percent in the Economic Survey of 2021-22 and well below the IMF’s forecast of 9 percent.

The MPC noted that the “recovery in domestic economic activity is yet to be broad-based, as private consumption and contact-intensive services remain below pre-pandemic levels.” The RBI has also extended the on-tap liquidity schemes to contact-intensive sectors which will allow them to get access to credit at slightly lower rates.

“At the current time, we are still involved in mitigating the impact of the pandemic. Our underlying concern and objective is to put growth on a strong and self-sustaining path,” RBI Deputy Governor Michael Patra said in a press conference after the unveiling of the policy.

The MPC also seems to have got some cushion from inflation readings projections. The central bank has projected CPI inflation to peak in the current quarter (Jan-March 2022) and then trend downwards. It expects retail inflation to average 4.5 per cent in 2022-23 with Q1:2022-23 at 4.9 percent and Q2 at 5 per cent, with the implicit assumption that the monsoons would be normal.

“Prospects of a good Rabi harvest add to the optimism on the food price front. The outlook for crude oil prices is rendered uncertain by geopolitical developments even as supply conditions are expected to turn more favourable during 2022. While cost-push pressures on core inflation may continue in the near term, the Reserve Bank surveys point to some softening in the pace of increase in selling prices by the manufacturing and services firms going forward, reflecting subdued pass-through,” the MPC resolution said.

On higher government borrowings to finance the expanded capex plan announced in the Budget, Das said, “while the RBI will continue to focus on smooth completion of the government borrowing programme, market participants also have a stake in the orderly evolution of financial conditions and the yield curve.” It is expected that market participants will engage responsibly and contribute to cooperative outcomes that benefit all, he said. Yields on 10-year benchmark bonds fell 8 basis points to 6.72 per cent after the policy announcement. The BSE Sensex closed the day’s trade up 460 points.

“The RBI surprised by not only doubling down on its now familiar orthodoxy of keeping rates and stance unchanged, but also expressed a very dovish outlook for inflation for FY23, forecasting it at 4.5%. This comes despite higher oil and commodity prices, growth-supporting fiscal policy, continued economic normalisation, and a distinctly hawkish Federal Reserve,” said Aurodeep Nandi, India Economist at Nomura.

Higher oil and commodity prices remain a key risk to inflation. According to estimates, a $10 per barrel increase in the price of crude could increase consumer price inflation by 35 basis points. “This was the first policy of the calendar year and perhaps sets the tone for the rest of the year. Were that indeed the case, the RBI is likely to follow a gentle approach to the normalization and ultimately withdrawal of monetary support unlike Western central banks that have switched to a hyper-aggressive mode,” said Abheek Barua, Chief Economist, HDFC Bank.