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RBI Monetary Policy Update

October 08 2021 | Reading Time: 5 Minutes
Key Policy Decisions:
  • RBI is maintaining status quo, keeping the repo rate unchanged.
  • Consequently, the policy repo rate remains unchanged at 4%. The stance remains accommodative as long as necessary to revive and sustain growth. 
  • The reverse repo rate also remains unchanged at 3.35%.
  • The marginal standing facility (MSF) rate and the bank rate remain unchanged at 4.25%.
  • The central bank revised its FY22 CPI inflation projection to 5.3% from 5.7%.
  • It maintains FY22 GDP growth forecast at 9.5%.
 
The decision on the repo rate was a unanimous one, and five out of six favored an accommodative stance.
 
Outlook for Inflation:
RBI has set an inflation target of 4% with a deviation of +/-2%. Consumer price index (CPI) inflation breached the upper tolerance threshold of 6% in May and June, driven by supply-side pressures in food, fuel and core inflation. However, it eased to 5.3% in August 2021, mostly due to moderation in momentum and a favorable base effect. CPI inflation for July-September was lower than anticipated.
CPI inflation is projected to move to 5.1% in Q2, 4.5% in Q3, and 5.8% in Q4, from 5.6% during Q1 FY22, with risks broadly balanced. RBI revised its FY22 CPI inflation projection to 5.3% from 5.7%.
 
Period CPI (Projected)
Q2 FY22 5.1%
Q3 FY22 4.5%
Q4 FY22 5.8%
FY22 5.3%
FY23 4.5-5.2%
 
Assuming normalization of supply chains, improvement in vaccination rate, a normal monsoon, and no major exogenous or policy shocks, RBI’s structural model estimates inflation of 4.5–5.2% for FY23.
 
CPI Inflation (Actual versus Projection in April 2021 MPR)
 

Source: RBI Website
In April MPR, RBI had estimated CPI inflation of 5.2% for Q1 and Q2 FY22. However, the actuals came in above estimates by 40bps and 20bps, respectively.
 
Drivers of CPI Inflation:
 

 
Source: RBI Website
 
Growth Outlook
 
Aggregate demand somewhat recovered in August–September. This recovery is reflected in high-frequency indicators such as railway freight traffic, port cargo, cement production, electricity demand, e-way bills, GST, and toll collections.
Considering various factors, the projection for real GDP growth is retained at 9.5% in FY22, consisting of 7.9% in Q2, 6.8% in Q3, and 6.1% in Q4. Real GDP growth for Q1 FY23 is projected at 17.2%.
 
Period GDP (Projected)
Q2 FY22 7.9%
Q3 FY22 6.8%
Q4 FY22 6.1%
Q1 FY23 17.2%
FY23 7.8%
 
For FY23, RBI’s structural model estimates have real GDP growth of 7.8%, assuming restoration of supply chains, a normal monsoon, no major exogenous or policy shocks, and full vaccination. Quarterly growth rates are estimated to be 5.0–17.2%.
 

 
Source: RBI Website
 
The central government’s mega schemes such as the National Infrastructure Plan (NIP) amounting to Rs 100 lakh crore and the National Monetisation Pipeline (NMP) involving Rs 6 lakh crore are expected to provide a major thrust to infrastructure spending and thus uplift potential output. The NMP is expected to unlock the value of investments in brownfield public-sector assets by tapping institutional and long-term capital and by leveraging further public investment.
 

Source: RBI Website
 
GDP Projections versus Actual Outcomes 
Actual real GDP for Q1 came in at 20.1%, below the April 2021 MPR projection of 26.2%, mostly due to the second wave of the pandemic which brought about restrictions.
 

 
Source: RBI Website
PFCE – Private Final Consumption Expenditure
GFCE – Government Final Consumption Expenditure
GFCF – Gross Fixed Capital Formation
 
Balance of Risks
Various factors such as domestic and international macroeconomic and financial conditions will affect the baseline projections of inflation and growth.  
Four factors will play a significant role in determining the trajectory of inflation and growth. Impact on inflation and growth trajectories, and deviation of each factor from the baseline are explained below.
 
(i) Global Growth Uncertainties
 
Global growth remains uncertain in view of the uneven spread of vaccination across countries and the more contagious variants of the virus. Global commodity prices have been quite volatile and the elevated uncertainty over the normalization of the U.S. monetary policy would pose uncertainties related to global growth.
 
If global recovery slips by 100bps below the baseline, the domestic growth rate and inflation could slide by around 40bps and 30bps, respectively. On the flip side, if global growth has a 100bps upside, the domestic growth rate and inflation could edge upward by around 40bps and 30bps, respectively.
 
(ii) International Crude Oil Prices
 
International crude oil prices have risen due to a sharp recovery in economic activity and improvement in global demand. OPEC+ countries are adhering to self-imposed production cuts.
 
On the supply side, if OPEC+ countries decrease production and geopolitical tensions rise, supply could be constrained, which would push up oil prices above the baseline. On the demand side, if COVID-19 subsides, global growth could accelerate, which would raise international crude oil prices.
 
Assuming crude oil prices to be 10% above the baseline, domestic inflation could rise 30bps and growth subside around 20bps over the baseline. Conversely, if the price of crude falls 10% relative to the baseline, inflation could ease by around 30bps while growth would have a boost of 20bps.
 
(iii) Exchange Rate
Due to the global and domestic factors, the Indian rupee has exhibited two-way movements over the past six months.
A 5% depreciation of the rupee from the baseline in such a scenario could raise domestic inflation by up to 20bps, while GDP growth could be higher by 15bps because of a boost to exports.
 
However, if the rupee appreciates by 5% relative to the baseline, the inflation and growth rates could moderate by around 20bps and 15bps, respectively.
 
(iv) Food Inflation
 
After food inflation spiked in June, it moderated in July–August, driven largely by the deepening deflation of vegetable prices. Inflation in edible oil prices, however, remains substantially elevated at 33% in August.
Easing of international food prices could soften headline inflation by around 50bps. Conversely, further hardening of international food prices could increase headline inflation by around 50bps.
 
Liquidity and Financial Market Conditions:
 
RBI has maintained ample surplus liquidity to support a speedy, durable economic recovery. Liquidity adjustment facility (LAF) averaged Rs 9T per day in September as against Rs 7T in June–August 2021. Surplus liquidity rose even further to a daily average of Rs 9.5T in October (up to October 6). The potential liquidity overhang amounts to more than Rs 13T.
 
RBI’s secondary market G-Sec Acquisition Programme (G-SAP) has been successful in addressing market concerns and anchoring yield expectations in the context of the government’s large borrowing program. 
 
Total liquidity injected into the system in H1 FY22 through open market operations (OMOs), including G-SAP, was Rs 2.37T, as against an injection of Rs 3.1T in FY21. RBI would remain ready to undertake G-SAP as required and also continue to flexibly conduct other liquidity management operations such as operation twist and regular OMOs.
 
Since mid-January 2021, 14-day variable rate reverse repo (VRRR) auctions have been deployed as the main instrument under the liquidity management framework. Considering market feedback, it is proposed to undertake the 14-day VRRR auctions fortnightly thus: Rs 4T today as already notified; Rs 4.5T on October 22; Rs 5T on November 3; Rs 5.5T on November 18; and Rs 6T on December 3. RBI may also consider complementing the 14-day VRRR auctions with 28-day VRRR auctions similarly calibrated.
 
Additional Measures:
  • A three-year special long-term repo operation (SLTRO) of Rs 10,000 crore at the current repo rate was introduced for small finance banks in May 2021. This facility, set to end October, has been extended to December. It has been extended to small business units, micro and small industries, and other entities from the unorganized sector.
  • To further expand the countrywide reach of digital payments, RBI proposed to introduce a framework for retail digital payments in offline mode.
  • The transaction limit for the immediate payment service (IMPS), which offers instant transfer of funds domestically 24x7 through various channels, has been raised to Rs 5 lakh, up from the existing Rs 2 lakh.

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