Omicron effect & data signs indicate RBI may keep an accommodative policy

RBI policy expectations, RBI policy, RBI, Shaktikanta Das, RBI money policy, Bond market, Reverse repo, Repo rate, repo rate cut

Kya kare kya na kare yeh kaisi mushkil haye

Koi to bataye iska hal o mere bhai

This song from the movie Rangeela is what most central bankers might be humming right now. What to do and what not to do must be troubling them.

But why this state of flux again? Isn’t it very clear that the excesses created must be unwound sooner than later?

Well, that certainly was the case till Omicron made its debut. The uncertainty around how the situation could evolve with the new variant of the coronavirus could mean the central banks would have to go back to the drawing board yet again.

In India, the July-September quarter real GDP grew by 8.4% YoY — a data point that paints a cheerful picture. Government consumption spending also has started picking up pace from the previous quarter, another healthy trend. On the inflation front, while the CPI (Consumer Price Index) has been fairly docile, aided by a high base effect. We could see some inching up as the base normalises.

Even if one assumes that the Omicron variant leads to an economic slowdown — though that is remote — supply-side constraints may not abate, keeping inflation elevated. What, then, would be the path the Reserve Bank of India’s Monetary Policy Committee (RBI’s MPC) takes? The path to policy normalisation is what we think.

The RBI has already embarked on a policy normalisation path with the introduction of variable rate reverse repo (VRRR) auctions. This has also bumped up the short end of the rates, which were earlier hugging the reverse repo rate. The banking liquidity is at Rs 7 trillion — still higher than pre-pandemic levels. Including government cash balances, the number would be north of Rs 11 trillion.

Hence, we expect the current VRRRs to continue. There may even be longer tenor VRRRs if need be. Of course, that need not be restricted to a policy day announcement.

Can the MPC get more aggressive in taming liquidity? While there is a case, at the current juncture, given the new variant-led uncertainty, the MPC may well want to wait and watch before invoking newer liquidity tools. We, however, do assign a higher probability of the RBI initiating a narrowing of the repo-reverse repo corridor.

Before the pandemic began, this gap was at 25 bps (0.25%). We could see a 15/20 bps hike in reverse repo in the upcoming policy. By the February 2022 policy announcement, we could see the gap reaching pre-pandemic levels. The stance of the policy could still be kept accommodative to ensure the least disruption in the recovery process. There may be less urgency, therefore, to tweak the repo rate for now — maybe something to be considered in mid-CY 2022.

Markets may not materially alter course with a reverse repo hike decision, as the VRRR outcome has already seen a rise in the short-term yield curve. The yield curve is pricing in a much tighter policy outcome over time, which has been manifest in rising yields across the curve. Hence, yields are currently trading range-bound with lackluster activity.

If the central banker is watching the bond price movements, he may be actually tempted to ask, in Sholay style, “Ithna sannata kyon hai, bond walon!”

(The author is CIO – Debt & Head – Products, Kotak Mahindra Asset Management Company. Views expressed are personal.)

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