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RBI is in calm seas despite the storm of imminent US tightening

* The RBI has chosen to keep its policy repo rate, and all other related rates, unchanged. This decision was unanimous, but the MPC retained its accommodative stance on a 5-1 vote, the one dissident signaling that a neutral policy stance is probable two months hence, and a tightening thereafter.

* India’s broad money supply in Mar’20-Jan’22 (the pandemic period) has grown much slower than its 30-year average pace of growth, in marked contrast to the US, where M2 has grown faster YoY in every month from Mar’20 to Dec’21 than in any month between 1960 and 2019. The US needs to roll-back this extraordinary monetary accommodation; in India, there has been very modest monetary accommodation, so there is scant need for roll-back. However, despite our forecast of 4.3% average CPI inflation in FY23, we expect the policy rate to rise by 50bp in Sep-Dec’22, to preclude excessive depreciation of the INR while the US raises rates by 112.5bp in CY22.

* Pressure on the INR will be mild despite the US tightening much more than India. In the 5 years before the ‘taper tantrum’ of Q3CY13, India’s foreign exchange reserves stagnated below US$300bn, and import cover declined to a 15-year low in Sep’13. This time, by contrast, foreign reserves have increased by a third in the past 2 years (to US$630bn, or 14 months’ import cover), providing an ample cushion. In CY12, and the 4 quarters to Jun’13, India’s current account deficit (CAD) had soared to an all-time high of 5% of GDP; this time, the 4qma of the CAD was just 0.4% of GDP in Sep’21, and was well-funded by net FDI inflows alone, with FII and other inflows providing an additional cushion.

The RBI’s monetary policy committee (MPC) voted unanimously to retain its policy repo rate under its liquidity adjustment facility (LAF) at 4%, and also to keep the reverse repo rate under the LAF at 3.35%, and the marginal standing facility (MSF) and Bank rates at 4.25%. The MPC voted 5-1 in favour of retaining the accommodative stance of monetary policy, citing that private consumption expenditure (PCE) had not yet regained the pre-Covid level, and there were continuing global headwinds (Omicron, high oil prices, geopolitical risks) that added uncertainties to the global and Indian growth outlook. The principal factor allowing the RBI to retain its accommodative stance is that CPI inflation remains within the RBI’s target range – albeit edging up to the higher end of that range in Dec’21 (to 5.59% YoY, with Jan’22 also likely to see high inflation). The RBI is confident, however, that CPI inflation will ease to 4% YoY by Q4-FY23.

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