Before the Omicron variant of COVID-19 took over the epidemiological and markets discourse, there was a reasonable likelihood that the Monetary Policy Committee would signal to the Reserve Bank of India (RBI) would start the normalisation process of monetary policy at its December 6-8 meeting with a small, maybe 15 basis point, hike in the reverse repo rate.
It has to be noted here that changing the reverse repo rate, and consequently the width of the policy rates corridor, is the domain of the RBI, not the MPC. But the balance of probability has again shifted towards a status quo, given the emerging uncertainties due to travel and other restrictions due to a fear of a renewed wave of infections.
The RBI has emphatically communicated on multiple occasions that it will proceed with normalisation not in a time dependent, but a state dependent (with a data driven approach) in a gradual, and calibrated fashion with advance telegraphing. This it has already done with the steady rise in both the average and cut off yields in the Variable Rate Reverse Repo (VRRR) auctions.
Other than the potential fresh public health uncertainty, the recent and expected growth-inflation trade-off dynamics had warranted a start of normalisation, which had been pointed out by some MPC members during the last policy review in October.
The recovery, both globally and in India, continues, although the momentum has been decelerating, and China’s loss of growth momentum is becoming a matter of increasing concern. In many of the large developed countries, inflation has remained high over the past few months, and is expected to persist into the first half of 2022. Labour markets, particularly in the United States and the United Kingdom, remain tight, engendering concerns of wage inflation spilling over into wider price pressures. There is a shortage of labour across a range of professions, further exacerbating price pressures. Housing markets remain strong in many geographies.
The US Federal Reserve has initiated a tapering of its Quantitative Easing (QE) bond purchase programme, starting in November itself, and scheduled to complete in June 2022. The Bank of England has been signalling a hawkish approach to normalisation, even though it surprised markets by voting with a large majority on a stay. Many smaller advanced economy, and emerging markets central banks have increased their policy rates.
In India, there were signs of a good pre-festive demand activity in September and October. Retailers had reported a pickup in consumer durables sales, although probably not at extraordinary levels. October exports had remained strong, although some of this was probably due to high crude oil, metals, and commodity prices. Exporters’ order books were also reported to be strong, with inability to fulfil the orders due to supply dislocations.
The Manufacturing PMI had started to rise since September, indicating rising output (although even here, some part would be due to rising input costs and output prices). Surprisingly, even Services PMI had started to rise quite sharply (from 45.4 in July to 58.4 in October). This is corroborated by rising air and surface travel, rising freight loadings, and Google Mobility metrics of travel for recreation, and for groceries and pharmacies.
Axis Bank’s Composite Leading Indicator index, tracking 39 nowcasting type data fields, had suggested a sharp rise in October. In addition to the indicators mentioned above, we observed a sharp rise in e-way bills, which are filed-in GST returns (from a low of 4 crore in June ’21 to 5.5 crores in July, and then on to 7.4 crore in October). The GST collections have also validated this, with latest reports of Rs 1.37 lakh-crore collected as GST in November (reflecting returns of activity in October).
There had been a slowdown in November, after the festival season stocking, but activity is primarily seen in e-way bills in the second half of November. The marriage season (generally the winter months) is reported to be robust. On the rural front, other than government subventions, after a record kharif harvest, the conditions for a good rabi harvest are also encouraging.
Inflation, on the other hand, remains a worry. Although the MPC will be going into its review with two moderate CPI inflation prints for September and October, these were partially due to favourable base effects, which forecasts suggest will weaken in Q4 FY22, thereby leading to a sharp rise to a forecast 5.9 percent (from an expected 5 percent in Q3). Fortunately, the drop in crude oil prices due to the combination of the Omicron concerns, and concerted action to release strategic oil reserve, is likely to provide some relief, but there are fears that this might be short lived.
Being risk averse both by its mandate and disposition, the MPC and the RBI will probably choose to be conservative given evolving risks, and will hold off on normalisation till February, when the public health risks become clearer.
Saugata Bhattacharya is Executive Vice President, and Chief Economist, Axis Bank.
Views are personal, and do not represent the stand of this publication.