The minutes of the Reserve Bank’s February policy meeting – in which interest rates were left unchanged – show that the MPC remains cautious on the inflation outlook but that it is also committed to keeping policy accommodative to ensure that the economic recovery becomes more entrenched. In all, we think markets are too hawkish in discounting modest rate hikes within the next 12-18 months, and expect rates to stay on hold for the foreseeable future.
- The minutes of the Reserve Bank’s February policy meeting – in which interest rates were left unchanged – show that the MPC remains cautious on the inflation outlook but that it is also committed to keeping policy accommodative to ensure that the economic recovery becomes more entrenched. In all, we think markets are too hawkish in discounting modest rate hikes within the next 12-18 months, and expect rates to stay on hold for the foreseeable future.
- The MPC voted unanimously to keep the repo rate and reverse repo rates unchanged at 4.00% and 3.35% respectively at the conclusion of its meeting on 5th February. We had thought that the drop in headline CPI inflation left the door ajar for a modest rate cut. It had eased from 7.6% y/y in October to 4.6% y/y in December (the last available print before the MPC meeting), and the latest data show that it edged down further to 4.1% in January. (See Chart 1.)
- But the minutes to that meeting (released yesterday evening) show that most MPC members remain cautious on the inflation outlook. Dr Michael Patra noted that “the relentless hardening of international crude prices is worrisome”, while Dr Mridul Saggar highlighted the “stickiness” of core inflation. For what it’s worth, we expect inflation to come in lower than the MPC expects over the next year. But the reluctance to lower rates in February and the cautious commentary suggest that further rates cuts are now unlikely.
- At the same time however, the MPC minutes support our view that rate hikes are a long way off. There is growing optimism over the recovery, especially given that new COVID-19 cases remain very low and that fiscal support is set to be ramped up following the unexpectedly accommodative Budget announcement for FY21/22. Nevertheless, the economy will still suffer repercussions from the crisis over the coming years, most notably a heavily impaired banking sector. That will prevent a rapid return to the pre-crisis GDP trend.
- The MPC committed during the policy announcement itself to “continue with the accommodative stance of monetary policy as long as necessary – at least through the current financial year and into the next year – to revive growth on a durable basis”. Governor Das added further colour to this as he revealed in the minutes that “growth momentum… needs to strengthen further for a sustained revival of the economy and for a quick return of the level of output to the pre-COVID trajectory”.
- Admittedly, the decision to reverse last year’s temporary cut to the cash reserve ratio (CRR) could be interpreted as a sign that the RBI is gearing up to tighten policy (the CRR will be raised from 3.00% to 3.50% in March, and to 4.00% in May). But the minutes make clear that this measure would “open up space for variety of market operations of the RBI to inject additional liquidity” and, indeed, the RBI has announced plans to ramp up its OMOs since the meeting.
- Bringing all of this together, we think that markets are too hawkish in discounting modest hikes within the next 12-18 months. We expect the repo and reverse rates to be kept on hold at their current low level for the foreseeable future. (See Chart 2.)
Chart 1: Consumer Prices (% y/y)
Chart 2: RBI Repo Rate (%)
Sources: CEIC, Capital Economics
Sources: Bloomberg, Capital Economics
Shilan Shah, Senior India Economist, email@example.com