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Monetary policy more dovish than expected

Growth optimism intact, but near term hiccups limit upside

Inflation forecasts in line with our expectations

* The MPC decided to keep policy rates unchanged – the repo rate at 4%, the reverse repo rate at 3.35%, and the MSF at 4.25% – as well as maintain its accommodative stance. Just like in the previous policy statement of Aug’21, the decision on rates was unanimous, but that of keeping the stance unchanged was decided based on a 5:1 majority, with Prof. Jayanth R. Varma being the only one expressing his reservations.

* Inflation projections were revised down to 5.3% in FY22, from 5.7% targeted earlier, in line with our expectations. The growth forecast, on the other hand, was kept unchanged at 9.5% YoY for FY22 (higher than our expectation of 8.8%).

* The surplus liquidity in the banking system has widened off late. The RBI announced two measures to manage this surplus liquidity: a) to not undertake any further G-SAP operations unless warranted by evolving liquidity conditions and b) based on the huge participation, it has proposed to further undertake the 14-day Variable Rate Reverse Repo (VRRR) auctions on a fortnightly basis in the following manner: INR4t on 8th Oct’21, INR4.5t on 22nd Oct’21, INR5t on 3rd Nov’21, INR5.5t on 18th Nov’21, and INR6t on 3rd Dec’21. Importantly, the central bank assumes that even after all such operations to manage liquidity, only INR2-3t is likely to be absorbed, implying that a large portion of liquidity surplus will still remain in the banking system.

* As against the general market expectation of a hint in its communication towards normalization of monetary policy (including a hike in the reverse repo rate), the forecasts and announcements made on 8th Oct’21 seemed rather dovish. Overall, the commentary by the MPC on 8th Oct’21 points to only a gradual reversal of its expansionary monetary policy and not until the economy visibly gets back in shape.

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