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The December policy review is expected to see the Monetary Policy Committee (MPC) and Reserve Bank of India (RBI) maintaining status quo on interest rates and monetary policy stance, while shifting the tone to prepare the markets for a change in February.

In October, the MPC had expectedly voted unanimously to maintain the policy repo rate at 4%. Amid one dissenting vote, it had decided to continue the accommodative stance for as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of covid on the economy, while ensuring that inflation remains within the target going forward. As we had anticipated, the RBI had maintained the reverse repo rate at 3.35%, while continuing to gradually normalize liquidity.

Arguably, the most important remark of the last policy review was that with output trailing the pre-pandemic level, the recovery remains uneven and dependent upon continued policy support. The Q2FY22 GDP marginally exceeded the pre-covid level, and the 8.4% pace of year-on year (y-o-y) growth surpassed the MPC’s forecast of 7.9%. However, the disaggregated data does not contain convincing signs of durability, in our assessment, with both private and government consumption meaningfully trailing the pre-covid level.

Moreover, after a broadly healthy festive season, some indicators had lost steam in November. Most telling is the decline in the daily average generation of GST (goods and services tax) e-way bills to 2 million in 1-28 November from the record-high 2.4 million seen in October. Further, fuel sales as well as port cargo traffic contracted in y-o-y terms in November.

The second supplementary demand for grants presented recently by the government has pencilled in substantial additional expenditure of 3 trillion, a part of which may be offset by savings found under other departments. Regardless, the fiscal impulse of the new allocations aren’t uniformly growth-positive; for instance, the equity infusion into Air India Assets Holding Ltd, as well as higher fertilizer subsidy necessitated by skyrocketing prices.

Overall, with the renewed uncertainty generated by the Omicron variant of covid-19, we believe the MPC will leave its GDP forecast of 9.5% for FY22 unchanged. In our view, recent data and developments do not suggest that the MPC’s durability criterion has been met, for changing the accommodative stance to neutral.

Further, the CPI inflation eased appreciably below 5% in September-October, the excise and VAT cuts on fuels have cooled prices, and the rabi sowing is brisk. At the same time, prices of staple vegetables have risen, and could stay uncomfortably high for a couple of months. Moreover, producers facing margin pressure on account of commodity prices and logistics costs have raised prices in several sectors.

We now expect the CPI inflation to average 5.5% in FY22, higher than the MPC’s forecast of 5.3% made in the October review. However, it is likely to remain within the MPC’s medium-term target range of 2-6%.

Accordingly, we expect a status quo from the MPC and the RBI in the December policy review on the stance and rates. However, the tone is expected to harden, to signal an upcoming change in the monetary policy stance to neutral in the February policy review, as long as fresh lockdowns don’t re-emerge in the coming weeks.

We expect the stance change to be accompanied by a 15 basis point (bps) hike in the reverse repo rate by the RBI in February, narrowing the policy corridor to 50bps from the current 65bps.

Thereafter, our base case continues to pencil in hikes of 25bps each in the repo and reverse repo rates each in the April and June reviews, followed by a reassessment of the durability of the growth revival as policy support is withdrawn.

Aditi Nayar is chief economist at ICRA.

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