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Brickwork Ratings, Bengaluru, 06 December 2021: The Monetary Policy Committee (MPC) is to announce the policy decision on 8 December in its bi-monthly monetary policy meeting. The betterthan-expected GDP numbers for Q2FY22 have provided much-needed comfort to the MPC on the growth outlook, while the new Covid variant Omicron weighs concerns on sustaining this recovery. Supply-side concerns are impacting the price level as well, although decline in oil prices witnessed in the last couple of weeks should bring in some comfort. The RBI is likely to continue with its accommodative monetary policy stance for some more time, but to start draining out excess liquidity in the system by reducing open market purchases, considering the build-up in inflationary pressures. BWR expects the RBI MPC to adopt a cautious approach and hold the repo rate at 4%.

Growth Outlook: The latest estimates of the GDP for Q2FY22 released by the Ministry of Statistics and Programme Implementation (MOSPI) are more optimistic than what the market had expected. In Q2FY22, the GDP expanded by 8.4% (year-on-year) close to BWR’s estimates of 8.3%. Agriculture activities continued to grow at a rate of 4.5%, while the industry and services sectors reported 6.9% and 10.2% growth, respectively. Growth in public administration, defense and other services has been encouraging due to the increase in public expenditures in Q2. On the expenditure components of the GDP, the increase in the gross fixed capital formation at 11.1% bodes well for the growth outlook. Pointing towards a robust recovery in the economic activities, the composite PMI output index rose to 59.2 in November (58.7, October) the highest since January 2012. Decline in the number of Covid19 cases, coupled with an increasing proportion of the population having been vaccinated, paved the way for an upward revision in the growth outlook, while the emergence of a new Covid variant Omicron weighs renewed concerns. The RBI is likely to revise upwards its GDP growth outlook for FY22 in the December MPC.

Inflation Scenario: Since the October MPC meeting, the overall CPI inflation has eased, largely due to a favourable base effect; however, core and fuel inflation increasing, with the former crossing 6% in October 2021, is a matter of concern. Rising industrial raw material prices, higher transportation costs and a shortage of chips are impacting production and prices in a number of industries. Unseasonal rains in several parts of the country and elevated crude oil prices are likely to increase food and fuel inflation as well. International crude oil prices have come down in the last couple of weeks, although retail prices are yet to be impacted by the same. The transient effect of the input cost pressure emanating from rising commodities and supply constraints was already reflected in the WPI, and it could affect the CPI inflation in the near future. The surge in prices is mainly a supply-side phenomenon, but with surplus liquidity in the system, it may become a general inflationary phenomenon. Although the overall CPI has been below the upper range of the inflation target rate of 6%, the threat of inflation in the near term is real. Hence, the RBI is advised to drain excess liquidity and monitor the situation closely.

Interest Rates: To lessen the economic consequences of the Covid-19 pandemic, the RBI brought down the repo rate to a record low of 4% from 5.15% and has kept the rates unchanged since May 2020. Furthermore, to enable the smooth functioning of financial markets, the RBI announced additional liquidity boosting measures and sector-specific measures, and continued with the accommodative policy stance. All these measures helped keep the cost of funds low and restrict the hardening of yields despite increased government borrowings.

With the Fed beginning its tapering, there are clear indications that the interest rate structure has bottomed out. The inflation rate in the US is at a record high, and tapering will continue, although this is not likely to have a major impact on India unlike during the 2013 tapering. Although India is faced with the risk of inflation breaching the comfort zone, to a considerable extent, this is due to supply factors. With economic recovery gathering some strength, the RBI may begin the mopping of excess liquidity, in a calibrated manner. However, the RBI is likely to maintain the repo rate at the current levels at least in the current fiscal.

Expectations from the RBI MPC

With consumer price inflation easing to 4.48% in October 2021, an improved supply situation on the back of the pandemic-led restrictions being relaxed, and capacity utilisation still in the recovery mode, there is no immediate pressure on the MPC to either alter interest rates or change the accommodative stance. The economy is well under recovery, however, the new Covid variant Omicron weighs concerns on sustaining this recovery. Thus, we expect the MPC to maintain the accommodative stance in the current fiscal to nurse the economic recovery.

We expect the RBI MPC to adopt a cautious approach and hold the repo rate at 4%, and start draining out excess liquidity in the system, considering the risk of inflation emanating from the rising commodity prices and input costs. The outlook on inflation may remain unchanged for the current fiscal, while upwards revision in GDP outlook is likely. The statement is keenly awaited for its forward guidance on inflation and the GDP for the next fiscal.

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