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

RBI will keep policy loose for a long time to come

India Economics Update
Written by Shilan Shah
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The RBI kept the repo and reverse repo rates on hold today and made an explicit commitment to keep policy “accommodative” for the foreseeable future. Markets are too hawkish in expecting modest rate hikes within the next 12-18 months.

  • The RBI kept the repo and reverse repo rates on hold today and made an explicit commitment to keep policy “accommodative” for the foreseeable future. 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. The cash reserve ratio remains at 3.00%, while the marginal standing facility rate also remains unchanged at 4.25%.
  • The main reason for policy inaction today is the stickiness of inflation. Headline CPI inflation has risen from 5.8% y/y at the start of the crisis in March to 7.6% y/y in October (see Chart 1), and the accompanying statement noted that elevated inflation “constrains monetary policy at the current juncture”. The stronger-than-expected recovery in growth also appears to have convinced the RBI to keep its powder dry. GDP contracted by 7.5% y/y in Q3 (Q2 of FY20/21), which was shallower than projected by the RBI’s unofficial “nowcast” of -8.6%. Today’s statement also noted that “high frequency indicators point to a recovery gaining traction”.
  • Looking ahead, an effective COVID-19 vaccine would provide a further boost to the recovery. We recently revised up our GDP forecasts for 2021 and 2022. (See our Update, “Oxford vaccine is a shot in the arm for the economy” 30th November.) However, the damage already inflicted on the labour market, firms, and the banking sector has been severe. We think GDP will still be around 6% below its pre-virus levels at the end of 2022. In relative terms, that would make India’s recovery one of the weakest among major economies over the next couple of years.
  • On the inflation outlook, our view is that core price pressures will drop back as some of the supply chain problems associated with containment measures gradually get resolved and the weakness in demand more than offsets supply constraints. While Governor Das sounded more concerned on the inflation outlook than in the previous meeting, the RBI is still expecting a drop in headline inflation to 4.6-5.2% in the first half of FY21/22.
  • The other instructive point from today’s announcement is the RBI’s commitment to “continue with the accommodative stance as long as necessary – at least during the current financial year and into the next financial year”.
  • Bringing all of this together, we see little prospect of the RBI tightening policy any time soon, and we think that markets are too hawkish in expecting (modest) rate hikes within the next 12-18 months. (See Chart 2.) In fact, on balance, there is still a chance that the RBI loosens policy if the drop in inflation turns out to be particularly sharp. Either way, with the central bank also appearing committed to ramping up its open market operations, bond yields – which have remained flat since the announcement – are likely to remain at their current low level for a long time to come.

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