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Expert View
RBI is likely to follow the Fed on rate hikes
A reverse repo liftoff is more likely in the Dec policy rather than in the Oct policy
We expect the monetary policy committee (MPC) to keep all key policy rates unchanged in the upcoming monetary policy on 8 October. Just like the US Fed has signalled to the market that tapering of asset purchases should not be interpreted as a timing signal for rate hikes, we think the Reserve Bank of India (RBI) will also communicate the same in the upcoming monetary policy. Or in other words, RBI will gradually start the normalization process in the October policy, but do so while keeping the accommodative monetary stance unchanged, thereby delinking its liquidity absorption actions from acting as a timing signal for a potential increase of the policy repo rate in the short term.
With the ₹2 trillion seven-day variable rate reverse repo (VRRR) cutoff rate coming at 3.99% in the auction conducted on 28 September, questions have been raised whether this is a signal that RBI will consider start hiking the reverse repo rate in the October policy itself. We will be pleasantly surprised if RBI goes for it, but our view is that a reverse repo liftoff is more likely in the December policy rather than in the October policy. We think RBI will wait to see if covid-19 cases increase or not after the festival season in October, and if risks do not manifest, then the central bank can be ready to start hiking the reverse repo rate from the December policy.
The October policy, in the meantime, will be an appropriate time period to resort to durable liquidity absorption through the use of longer tenor VRRR, in our view. With RBI resuming 14-day VRRR auctions from August, and announcing more VRRR for 3-7 day tenor in recent weeks, the next logical step is to announce liquidity absorption through longer tenor VRRR (28-day or 56-day) in the upcoming policy. We expect ₹2 trillion in longer tenor VRRR to absorb liquidity on a durable basis. RBI will also likely reduce the quantum of G-SAP purchase for the October-December and January-March quarters (it should be about ₹75,000 crore in each quarter, if RBI decides to maintain the same proportion of G-SAP purchases to net market borrowing during 1HFY22), in our view, from the ₹1.2 trillion committed for July-September, and will likely conduct it in the form of “twist operations”, so as to not add further to the large liquidity surplus.
We think two 20 basis points (bps) reverse repo rate hikes in December and February policies will be the ideal pace of sequencing, rather than going for a 40bps hike in one go, either in the December or February policy. We expect the accommodative monetary stance to remain unchanged in December as well, even as RBI increases the reverse repo rate by 20bps to 3.55%, by end-2021. If India manages to escape a third wave, then the accommodative stance will likely be changed to neutral in the February policy, along with another 20bps hike in reverse repo to bring it up to 3.75%. Thereafter, we expect RBI to hike the repo rate gradually by 50bps in 2022, 50-75bps in 2023 and another 25bps in 2024. Terminal repo rate is expected to be lower at 5.50% in the post-covid environment.
There are essentially four downside risks to growth: resurgence of a third wave in the coming months; global oil and energy prices remaining elevated, resulting in a negative impulse for private consumption expenditure growth; slowdown in export momentum led by a moderation in global economic activity; and medium-term scarring effects of the health crisis, preventing private consumption and investment from returning to pre-pandemic trend. Despite these risks, we expect RBI’s FY22 real GDP growth forecast to be maintained at 9.5% year-on-year (our forecast is the same). Meanwhile, the lower-than-expected CPI (consumer price index) prints in the past few months and softer vegetable prices in September will likely result in RBI revising its FY22 CPI inflation forecast to 5.1-5.2% (our own estimate is 5.2%), from 5.7% average currently. Despite a lower CPI, core CPI is expected to stay sticky around 6% for the next six months.
Kaushik Das is India chief economist, Deutsche Bank.
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First Published:4 Oct 2021, 12:58 AM IST
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