RBI will keep policy loose for a long time to come - Capital Economics
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RBI will keep policy loose for a long time to come

India Economics Update
Written by Shilan Shah
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The MPC voted to keep the repo and reverse repo rates on hold today but committed to keeping policy “accommodative” for the foreseeable future. We no longer expect any more rate cuts, but markets are too hawkish in expecting modest rate hikes within the next 12-18 months.

  • The MPC voted to keep the repo and reverse repo rates on hold today but committed to keeping policy “accommodative” for the foreseeable future. We no longer expect any more rate cuts, but markets are too hawkish in expecting modest rate hikes within the next 12-18 months.
  • The MPC’s unanimous decision to keep the repo and reverse repo rates unchanged at 4.00% and 3.35% respectively today was widely expected by most, though we were in a minority of analysts expecting a 25bp rate cut. The marginal standing facility has also been left unchanged at 4.25%.
  • The key reason we had expected a cut today was the sharp drop in headline CPI inflation, from 7.6% y/y in October (the last print before the previous MPC meeting) to 4.6% y/y in December. (See Chart 1.) Daily data suggest a further drop in inflation in January. But this did not sway the MPC. Indeed, the Committee continued to sound cautious on the inflation outlook, with easing supply chain disruptions and recovering commodity prices presenting downside and upside pressure respectively. For what it’s worth, while we expect inflation to come in lower than the MPC is expecting over the coming year, we do think that the sharp falls are already behind us.
  • In addition, the growth outlook has turned more positive over the past couple of months, which also appears to have convinced the Committee to stand pat. Governor Das stated that “signs of recovery have strengthened further since the last meeting” and that measures announced during the Union Budget for FY21/22 would help to “reinvigorate domestic demand”. That appears a reasonable assessment. (For more see our Update, “At last, the Finance Ministry breaks the shackles”, 1st February.)
  • Given this, it seems that further cuts to policy rates are now unlikely. At the same time however, rate hikes look a long way off. For all the optimism over the recovery, 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. Most instructive in this regard, Governor Das noted that the RBI would “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”.
  • 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). However, in what was most likely a way of tempering any adverse market reaction, Governor Das stated that this measure would “open up space for variety of market operations of the RBI to inject additional liquidity”. That surely raises the prospect of more open market operations to keep long-term bond yields in check. After all, the RBI will be keeping a closer eye on bond market movements as the public debt trajectory will have worsened as a result of the fiscal stimulus.
  • 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: Repo Rate (%)

Sources: CEIC, Capital Economics

Sources: CEIC, Capital Economics


Shilan Shah, Senior India Economist, shilan.shah@capitaleconomics.com