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Dovishness reinstated

The minutes of Feb’22 policy reaffirmed the MPC’s dovish stance on net, largely hinging on the weak growth narrative. Most believe growth may have lost some momentum, remains sub-par, and needs policy support to draw near the lost ground. Monetary policy complementarity and favorable financial conditions are still needed.

The inflation narrative saw coherence among members, with most seeing it peak and moderate ahead. The persistence of supply-side inflation shocks on account of 1) commodity price shocks due to geopolitics and 2) dragging supply chain disruption, may be countered by weak demand dynamics. Prof. Goyal and Dr. Patra took a hard line on excessive inflation targeting, stating that the output sacrifice -required to tame supply-driven inflation can be very high. Dr. Patra seemed critical of DM central banks’ supposed rear-view mirror outlook on inflation.

While members unanimously kept the rates unchanged, they slightly differed on the medium-term policy response to the divergent global rate scenario. Governor Das and Dr. Patra argued that the policy response should depend on domestic dynamics and not solely in response to DM policies. Prof. Goyal reckoned the elevated term premia reflected market overreaction. Dr. Saggar and Prof Varma, however, think that rates need to rise ahead in line with changing global dynamics, albeit gradually.

We maintain that the RBI has some flexibility to delay rate hikes. Amid elevated term premia, India's current real rates look reasonable vs. peers, given the present crosscurrents. Policy rate hikes will be well-telegraphed, shallow and pushed to H2FY23, with RBI in an active wait-and-watch mode. However, we reckon the gradualist approach toward normalization could be challenged by various global and domestic push-and-pull factors.

Dovish stance reaffirmed, largely hinged on growth

Even as the MPC was split on the accommodative stance, the majority of the members felt there was still room to support growth amid a moderating inflation trajectory ahead. That said, most of them were cognizant of the risks posed by changing global and domestic dynamics. Broadly, most members believed that economic indicators depicted mixed signals as seen through high-frequency economic indicators. Tepid private consumption, low consumer sentiment and declining discretionary household expenditure reflect incomplete and uneven growth so far. On net, even as economic recovery continues to gather momentum, it needs policy support to draw near the lost ground. Monetary policy complementarity and favorable financial conditions thus remain critical.

Watching the inflation space carefully and the output sacrifice ratios

Most members reckoned retail inflation has likely peaked and will moderate ahead. Weak demand side pressures were emphasized amid moderation in household expectations and high unemployment. Cost push inflation risk persists via rising commodity prices amid geopolitical concerns and still-elevated supply disruptions. Some members also argued for continued policy coordination between monetary and fiscal to control price pressures. However, prof. Goyal reckoned that in India, percolation of producer prices is lower on retail as food inflation dominates the inflation scenario. She noted that the output sacrifice required to tame supply-driven inflation can be very high if supply is elastic, as in India. Dr. Patra also stressed that using monetary policy to ease supply-side inflation will only destroy nascent demand. While he believes that our inflation dynamics are different from the western countries, he seems critical of their supposed rear-view mirror outlook on inflation, which would hurt growth.

Members slightly differ on medium-term policy response to divergent global rates scenario

Discussion on domestic rates amid changing global rates scenario assumed importance for some members. Prof Goyal thinks high rates and elevated term premia depict market overreaction on 1) Fed normalization, 2) higher borrowing requirement, and 3) equating India’s inflation with the west. As per her, India’s policy normalization had already begun with liquidity repricing in early 2021. Dr. Patra and Governor Das argued monetary policy reaction function should be focused on domestic dynamics amid growing divergence in policy responses on the global front. However, Dr. Saggar noted that as interest differential with DMs narrows and the current account widens, low for long interest rates will bring in macro imbalances and warrant rate hikes. But economic buffers against possible capital outflows imply that India can afford to go slow on normalization. Prof Verma, the sole dissenter on stance, argued that a modest rise in nominal interest rates is needed ahead to keep real rates mildly positive in FY23

Slow transition ahead

The stout policy signaling in the MPC meeting and generally dovish minutes imply the central bank would go slow on policy transition. The geo-political risks have risen substantially since the Feb’22 policy, and commodity price shocks could hit the economy hard if they persist. However, policymakers may not react immediately through the interest rate channel. We maintain our view that the RBI has some policy flexibility on hand, which will delay repo rate hikes. Amid ultra-elevated term premia, India’s current real rates look reasonable vs. EMs, given present crosscurrents. This could give some leeway to the RBI’s reaction function to conduct a shallow normalization. Policy repo rate hikes will be well telegraphed and shallow, and easily pushed to H2FY23, with the RBI in an active wait-and-watch mode.The fixed Reverse Repo normalization may happen in tandem with a repo hike, even as it is becoming less irrelevant and will likely act more like a standing facility ahead

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