RBI likely to hike reverse repo by 20 bps despite uncertainty on Omicron | Business Standard News

Clipped from: https://www.business-standard.com/article/economy-policy/rbi-likely-to-hike-reverse-repo-by-20-bps-despite-uncertainty-on-omicron-121120500949_1.html

If Omicron becomes a major issue, risks to India’s inflation will likely rise further

RBI, Reserve Bank of IndiaReserve Bank of India

Despite uncertainty related to the Omicron variant’s likely impact going forward, we think sufficient progress has been achieved on the macro front for RBI to hike the reverse repo rate by 20 bps to 3.55 per cent in the December policy, while maintaining the accommodative stance. With a 20 bps hike already being fully priced in, we think RBI should use this opportunity to increase the reverse repo rate, as the action is unlikely to have any meaningful impact for markets. Or, in other words, RBI should not have a problem to take actions which are non-disruptive for markets and already well anticipated by market participants in advance.

As long as RBI’s action does not rock the boat and only plays catch up with where market rates already are at the short end, we think the central bank will not have a problem. Currently, the RBI is absorbing about Rs 7.2 trillion liquidity through VRRR at a cut-off rate of 3.98 per cent and another Rs 2.7 trillion through fixed reverse repo at 3.35 per cent. The weighted average rate of such liquidity absorption is about 3.81 per cent, indicating that a 20 bps reverse repo hike to 3.55 per cent will not have any meaningful impact. In fact, if RBI does not do anything, then it will likely come as a surprise for markets.

The US Federal Reserve is likely to increase the pace of tapering in mid-December and drop the “transitory” characterisation of inflation, despite Omicron-related risks. The new variant has increased potential downside risks to global growth, but risks to inflation will also increase due to longer-than-expected supply-side bottlenecks which could in turn adversely impact inflation expectations. While the RBI does not need to follow the Fed in toto, we think the monetary authorities in India will surely factor in the Fed’s likely normalisation pace while deciding on the future monetary policy trajectory. In this backdrop, delivering a 20 bps reverse repo rate hike, while maintaining the accommodative stance, will be the best and least disruptive form of action from RBI, in our view.

Kaushik Das

Real GDP grew 8.4 per cent yoy in July-Sep’21, 50 bps higher than the RBI’s forecast of 7.9 per cent yoy, but given the uncertainty, we expect the central bank to maintain its FY22 growth forecast of 9.5 per cent yoy. In February 2020, RBI had provided a 10.5 per cent yoy real GDP growth forecast for FY22, which was later cut by 100 bps to 9.5 per cent, to factor in the impact of the second wave. For FY23, RBI has a provisional growth forecast of 7.8 per cent yoy. If we assume that the Omicron wave will not be as deadly as what India experienced during the second wave, and therefore not requiring a nationwide lockdown as was implemented in 2020, then the downward revision to FY23 growth is unlikely to be more than 100 bps. Even if we factor in a 100 bps mark down in growth during FY23, that would bring RBI’s growth forecast to about 6.8 per cent. Close to 7 per cent growth in FY23, even after factoring in the worst of the Omicron impact, should not come in the way of a 20 bps hike in reverse repo rate at this stage, in our view.

Meanwhile, inflation risks are clearly to the upside. We expect India’s CPI inflation to average 5.0-5.5 per cent in the post Covid-19 world, 100-150 bps higher than RBI’s target of 4 per cent. If Omicron becomes a major issue, risks to India’s inflation will likely rise further. Indeed, in the upcoming policy, the RBI may decide to increase the FY22 average CPI forecast to 5.5 per cent from its current 5.3 per cent, to incorporate the larger-than-anticipated increase in October and November inflation momentum. Considering the inflation risks, the RBI should not delay the calibrated normalisation process of hiking the reverse repo rate in the upcoming policy meeting.

Views expressed by the writer are personal

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