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We expect the central bank to maintain its accommodative stance in the forthcoming monetary policy on 4 December, but the tone of the guidance is likely to turn more neutral, in our view, compared to the significant dovish tilt that was characteristic of the October policy. That will probably be achieved with the central bank likely guiding the markets that room for further rate cuts has narrowed significantly or does not exist any more, given the recent developments related to growth and inflation. This should not matter much, as long as the central bank continues with its commitment of soft yield curve control (1) to ensure smooth functioning of the ongoing government borrowing programme; and (2) to arrest unwarranted volatility in the fixed income markets.

India’s CPI inflation has continued to surprise on the upside, with the October figure touching 7.6%, primarily due to higher vegetable prices. November CPI inflation is also likely to be around 7%. If food prices, particularly vegetable prices, do not fall meaningfully in December, in line with the normal seasonal trend, the damage will be done, and CPI inflation then can continue to be in the 6.5-7% range for the rest of the fiscal year, which will be significantly higher than the Reserve Bank of India’s (RBI’s) current forecast of 5.4-4.5% range for H2FY21 (October-March). After the October CPI print, we have revised up our CPI forecast for October-December to 6.6% average (from 6.1% earlier) and January-March to 5% (from 4.6% earlier). Even under this baseline scenario, CPI inflation is now expected to come down to about 5% in January, which will lead the FY21 average CPI to be around 6.3-6.5%.

RBI will probably have to increase its CPI inflation forecast (quarterly average) by at least 100bps for October-December (from its current forecast of 5.4%; Deutsche Bank October-December CPI forecast is 6.6%) and by 50bps for January-March (RBI’s forecast is 4.5%; Deutsche Bank estimate is 5%). That is not all. The central bank is also likely to revise up its GDP forecast for October-December and January-March (currently at -5.6% y-o-y and +0.5% y-o-y respectively). With the central bank likely to revise up both its inflation and growth forecast, we do not see any room for further rate cuts in this cycle. Since August, our view has been that RBI will not cut rates any further, but will maintain the policy repo rate of 4% for a prolonged period.

With the government recently announcing a new set of stimulus measures for different sectors, the need for RBI to reduce the policy rate further will reduce. This, along with recent upside surprises related to growth, higher-than-anticipated inflation prints and positive news on the vaccine front, should encourage the central bank to stay on the sidelines and shift its attention towards inflation management, in our view. While the MPC is unlikely to change the wordings of the October forward guidance significantly in December, given that it is still fresh, the February policy may carry a more hawkish tone (leading markets to price in an earlier-than-expected exit strategy), if inflation prints continue to surprise to the upside, growth trajectory continues to look better-than-anticipated and prospects of receiving a credible covid-19 vaccine becomes more certain by then.

While RBI may not want to hike the policy repo rate in a hurry, we think the central bank can potentially increase the reverse repo rate (currently at 3.35%) by 40bps in 2021. This is likely to be preceded by a CRR hike of 100bps by 2Q21, to reduce some amount of surplus liquidity in the banking system. We expect the central bank to increase the repo rate by 50bps in the first half of 2022.

Kaushik Das is India chief economist at Deutsche Bank AG.

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