View from CRISIL Research on MPC

10 Feb 2022 , 02:39 PM

The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) kept policy rates unchanged, with repo rate at 4%, reverse repo rate at 3.35%, and marginal standing facility at 4.25%.

The rates remain unchanged since the pandemic began, and are the lowest in a decade.

The focus of the RBI continues to be on supporting India’s GDP growth, which is expected to be a mere 1.3% above the pre-pandemic level this fiscal, according to the first advance estimates by National Statistical Office. The MPC showed concern about the recent softening in economic activity, and remains wary of the risks posed by successive Covid-19 waves.

Clearly, Mint Road believes it has space to support growth, given that headline CPI inflation remains within its target of 2-6%, and is projected to dip to 4.5% next fiscal. Exogenous risks have increased since the last monetary policy review meeting. Brent crude prices have jumped from $74.3 per barrel on average in December 2021 to over ~$90 now .

CRISIL Research expects Brent to average $80-85 in 2022, the highest since 2015. High crude oil prices adversely affect Indian macros such as the current account deficit, inflation, GDP growth, and in some cases, the fiscal deficit.

In the past, the RBI had raised policy rates during periods of rising crude oil prices, such as in 2010 (150 bps cumulative hike in repo rate), 2011 (225 bps), and 2018 (50 bps).

During his post-meeting speech, the RBI governor highlighted significant risks prevailing on account of crude oil prices. However, for inflation, the impact on inflation is expected to partially offset by lower excise duties on fuel relative to last year. The central bank remains concerned about the downside risks posed to GDP growth.

Secondly, the US Federal Reserve is expected to raise its policy rate at the fastest pace since the Global Financial Crisis.

S&P Global expects six hikes in 2022 itself (starting March), followed by five more in the next two years. The projected number of hikes in 2022 are much more than seen at the peak of the Fed tightening after the Global Financial Crisis (four rate hikes in 2018).

That peak had coincided with repo rate hikes by the RBI.  However, for now, Mint Road has chosen to manage external risks by gradually withdrawing excess liquidity, and having a dynamic approach by restoring the liquidity management framework of February 2020. It derives comfort from the resilience of the rupee despite tightening global financial conditions.

Through today’s policy, the RBI showed domestic factors remain its primary concern, and that it can chart a different policy trajectory relative to other advanced economies such as US. However, we believe domestic inflation, too, could face upside risks from surging crude oil prices. In addition, firms can increase pass-through of cost pressures to consumers as demand strengthens over the coming year.

Thus, we expect the RBI to start normalising its policy rates by April. We expect three hikes in repo rate by 25 basis points each, bringing it to 4.75% by the end of fiscal 2023. That will still be lower than 5.15% seen just before the pandemic (i.e., in February 2020).

The author of this article is Dharmakirti Joshi, Chief Economist, CRISIL Ltd.

The views and opinions expressed are not of IIFL Capital Services, indiainfoline.com