As expected, the Monetary Policy Committee (MPC) retained the stance of monetary policy as accommodative and kept the repo rate unchanged at 4.0 per cent in the February 2022 policy review.

By doing this, it chose to wholeheartedly support the incomplete growth recovery, with inflation being expected to peak this quarter and moderate thereafter, providing room to remain accommodative.

Simultaneously, the Reserve Bank of India refrained from hiking the reverse repo rate, in line with our own views, but contrary to the expectation of a segment of the market participants. We believe this is a wise move, as an increase in the reverse repo rate at this stage would have provided a conflicting signal for yield movement.

The MPC reiterated that the economic recovery is incomplete and yet to broad-base. It forecast the real GDP to grow by 7.8 per cent in FY2023, with a base-effect led surge in Q1 FY2023, being dampened by a low 4.3-4.5 per cent rise in H2 FY2023. The latter is surprisingly gloomy, trailing the broad market expectations of potential growth for the Indian economy.

At the same time, the MPC expects the CPI inflation to cool appreciably from 5.3 per cent in FY2022 to 4.5 per cent in FY2023, with risks broadly balanced. This suggests that a moderate outlook for domestic demand and growth may prevent the surge in global commodity prices being passed through to the end-consumers. Clearly, there is a tradeoff looming between boosting volumes and protecting margins.

For now, the MPC has chosen not to sacrifice growth in a futile attempt to control imported inflation. With no change in the voting patterns of the six members of the Committee (5:1 vote to continue accommodative stance), a withdrawal of policy support to growth does not appear imminent. Therefore, we no longer foresee a change in stance in April 2022.

Looking ahead

We now believe the monetary policy stance will be changed to neutral from accommodative in the June 2022 policy review. This will be followed by two repo rate hikes of 25 bps each in August 2022 and October 2022, based on our forecast that inflation will dip only gradually over the coming months. We still expect the first increase in the reverse repo rate will be dovetailed with the change in stance in June 2022, instead of preceding it.

The RBI made several announcements on the liquidity front, such as variable rate reverse repo (VRRR) operations of varying tenors, variable rate repo (VRR) and 14-day VRRR operations as the main liquidity management tools, along with fine-tuning operations to tide over any unanticipated liquidity changes.

This was done with a view to rebalance liquidity on a dynamic basis, by explicitly replacing the overnight fixed rate reverse repo auction with the 14-day VRRR auction, as the primary liquidity absorption tool. Moreover, to meet the transient liquidity mismatches and shortages, as seen recently when GST outflows exceeded expectations during the third week of January 2022, the RBI has formally introduced short tenure variable rate repo (VRR) auctions.

Along with a strong nudge to market participants to move out of fixed rate liquidity operations, the RBI brought back the reference to the orderly evolution of the yield curve. The combination of these factors is likely to flatten the curve going ahead. Already, the dovish tone and moderate inflation forecasts have helped the 10-year G sec yield to ease appreciably. Nevertheless, we do expect it to cross 7.0 per cent by April 2022, once the large FY2023 borrowing programme of the government commences.

In YoY terms, bank deposit and credit growth stood at 9.3 per cent and 8.1 per cent, respectively, as on January 14, 2022, entailing an incremental amount of ₹8.7 trillion and ₹5.2 trillion in FY2022 till date. With limited disruption being caused by the third wave, we maintain our YoY credit growth estimate at 7.3-8.3 per cent, with an incremental credit of ₹8.0-9.0 trillion during FY2022.

Moreover, we project incremental deposits of banks at ₹12.0-14.0 trillion during FY2022, which will translate to a YoY deposit growth of 8.0-9.3 per cent. With the hike in the size of VRRR operations and rise in short-term rates, large banks have already started increasing the short-term deposit rates from December 2021 onwards.

This trend will intensify over the course of 2022, mirroring the expected rise in the reverse repo and repo rate, as well as bond yields.

The writer is MD and Group CEO, ICRA Ltd

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