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Monetary policy remains accommodative, but with a subtly hawkish twist

Monetary policy remains accommodative with the policy repo rate unchanged at 4% (implying a negative real rate, at -2.1%). However, the RBI’s borrowing rate was effectively raised by 40bp to 3.75% with the introduction of a standing deposit facility (SDF), which will effectively replace the reverse repo rate (3.35%) as the floor of the liquidity adjustment facility (LAF). Absorbing excess liquidity by offering a higher interest rate amounts to a subtle policy tightening.

The RBI also acknowledged the rising risk of higher inflation, raising its forecast of average CPI inflation to 5.7% for FY23 (from 4.5% previously), while reducing its real GDP growth forecast to 7.2% (from 7.8% at the time of the last MPC meeting). We believe the RBI’s real GDP growth forecasts are too low, particularly for Q3FY23 (4.1% YoY) and Q4FY23 (4%). We agree with the RBI’s apprehensions about the global headwinds (see our recent note on recession risks (Link)), but believe domestic demand will rebound to take up the slack, as private investment in particular is crowded-in. The key to that rebound in private investment is a durable acceleration in bank credit

We expect the policy repo rate to rise by 25bp each at the next two meetings of the MPC (6-8th Jun’22 and 2-4th Aug’22), as high global commodity prices keep headline CPI inflation high. That tightening of monetary conditions and the likely rise in oil, gas and renewable-energy supply as a result of persistently-high crude oil prices, will help dampen global (and Indian) inflation in H2FY23, allowing the crowding-in of private investment.

Despite CPI inflation being above the top end of the policy band (2-6%, with 4%YoY as the official inflation target) for the last two months, the RBI’s monetary policy committee (MPC) decided to maintain the policy repo rate unchanged at 4%. The decision was unanimous. So was the MPC’s decision for monetary policy to “remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”. RBI Governor Shaktikanta Das clarified in his verbal remarks that the “withdrawal of accommodation” is envisaged to occur over a “multi-year period”. The precise wording, however, gives the RBI considerable flexibility – it will “focus on withdrawal of accommodation to ensure that inflation remains within the target” (which implies near-term restraint on money-growth or tightening of policy), while broadly remaining accommodative to “support growth”.

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