Monetary policy normalization in progress

Overall monetary policy was in line expecting no change in repo rate which is at 4%, and accommodative stance unchanged. RBI has reduced its inflation forecast to 5.3% for FY22 which was 5.7% earlier and expects it to be even lower for Q2 & Q3 of FY22. The inflationary expectations for 3 months as well as 1 year ahead have also fallen. RBI kept the FY22 GDP growth forecast unchanged at 9.5%, with Q2 and Q3 GDP growth numbers being revised up, focusing optimism about investment and consumer sentiment revival. The RBI has begun its gradual liquidity normalization process by the temporary stoppage of the G-Sap -2.0 program with the end of on-tap TLTRO liquidity the scheme by Dec21and reducing surplus liquidity by ~INR 6trn till Dec using VRRR and may keep surplus liquidity at ~INR 2-3trn. On the other hand, the 
US Fed is likely to delay their asset tapering announcement to Dec21 from the earlier anticipated Nov21with consecutive non-farm payroll data for the past 2 months averaging ~ 280k. This may give the RBI more space to adjust the system liquidity and push up the lower end of the yield curve by a) Increasing the reverse repo rate by 40 bps in FY22 to normalize the monetary policy corridor to 25bps; and b) 14-day VRRR auctions (and a possible 28-day VRRR later). Given the lower inflation trajectory for FY22, we 
expect the repo rate to be increased only in 1QFY23 as growth is likely to normalize and be broad-based by then. 

Business confidence improves steadily and reaches the highest since 2009 

RBI's business assessment index improved from 89.7 in 1Q to 116.7 in 2Q. This is higher than the pre-Covid level and achieved an LTA of 108 which is the highest since the start of the index in 2009. The expectations index has improved from 124.1 in 2Q to 135.7 in 3Q. This is also significantly higher than providing an LTA of 116 and the highest level since the start of the index in 2009. RBI's current consumer base has also improved from 48.6 in Jul21 to 57.7 in Sep21. But this is significantly lower than LTA of 9). The future expectations have improved from 104 to 107 during the same time when compared to the LTA of 116. The improved sentiments are in sync with the pickup in high-frequency indicators like railway freight traffic, cement production, electricity demand, e-way bills, and GST collection. 

GFCF likely to revive, robust export growth, resilient agriculture 

The FY22 GDP growth forecast is constant at 9.5%, Q2FY22 growth increased by 60 bps to 7.9%, and also the Q3FY22 GDP increased by 50 bps to 6.8%. RBI expects a CAPEX recovery cycle in semi-annual monetary policy statements due to the following reasons. Improvement in the interest coverage ratio of manufacturing units, PLI nurturing private investment, mega schemes like National Infrastructure Plan & National Monetization Plan to increase infrastructure spending; and Central governments assistance to remain robust likely to reach $400bn in FY22 as the mobility restrictions subside, export of labor-intensive sectors (apparel, leather products, tea) is likely to rise. In the agricultural sector, the Kharif foodgrain production in FY22 grew by 0.6% which was helped by good monsoon rainfall and increased MSP prices. Rabi production is likely to grow as reservoir levels are currently at 80% of the full reservoir level.GDP growth for FY22 and FY23 is likely to be at 9.8% and 9.4%, respectively. In Q2FY22 and Q3FY22 the economy is likely to grow by 6.7% and 7.7%, respectively. The downside risks to growth are supply constraints semiconductor and coal shortage, high cost of raw materials, uncertainty around COVID. 

RBI’s steps for Liquidity Normalisation 

The liquidity normalization process had started in Aug21. This was further scaled up in the Oct21 monetary policy meeting with the announcement of the fortnightly calendar for the 14-day VRRR auctions till the 1st week of Dec21. Apart from this the RBI also temporarily halted the G-Sap -2.0 program and announced the end of the On-tap TLTRO liquidity scheme by Dec21. All these measures may reduce the surplus liquidity in the system by ~INR 6trillion till Dec along with maintaining surplus liquidity at ~INR 2-3trillion. The RBI also proposed an introduction of the 28-day VRRR in the future. Starting with a short tenure (14-day VRRR) and moving forward with instruments with longer tenure will push up the cost of liquidity gradually. The RBI reiterated that policy normalization will be a gradual process based on evolving domestic conditions. It does not make any drastic change immediately as the situation is under control. 

Repo rates to hike in early Q1FY23 

From the policy stance and commentary which is provided later, it is clear that growth remains the top priority of the RBI at the present juncture. RBI is following the best practices of the other economies step-by-step with stoppage of measures like Quantitative Easing by halting G-SAP 2 temporarily, by normalization of liquidity (RBI auction of VRRR), and finally by normalization of policies. We expect a delay in the US Fed asset tapering announcement to Dec21 which has been anticipated in Nov21 due to low non-farm payroll data for the past 2 months averaging 280k, which will give the RBI more headroom to adjust the system liquidity before normalizing the policy rates. An increase in the reverse repo rate by 40 bps in FY22 to normalize the monetary policy corridor to 25bps is expected. Any hike in the repo rate is only likely in early 1QFY23 as growth is likely to normalize and be broad-based by 1QFY23.