In the midst of uncertainties, understanding will help the markets

The Monetary Policy Committee (MPC) and RBI had expected to maintain status quo on rates and stance in the final policy review of 2021. FY22 GDP growth and CPI inflation forecasts were maintained at 9.5% and 5.3% respectively, out of the quarterly forecasts with some recalculations. Simultaneously, the RBI emphasized the objective of re-establishing 14-day variable rate reverse repo auction as the main liquidity management operation, and from January, with liquidity absorption primarily through the auction route.

While the MPC appeared optimistic that domestic economic growth was gaining traction, it cautioned that the recovery needed continued policy support to make it more comprehensive. It also highlighted that the Indian economy is not untouched by the global spillover or the fresh waves of Covid-19, with global uncertainty reignited by the Omicron edition.

On the inflation front, the MPC commented that rising input costs are a risk to the core inflation trajectory, although their pass-through to final prices may be limited by the slowdown in the economy. Despite this, it commented on the need for continued normalization of excise duty and VAT rates, along with measures to address other input cost pressures, to consistently reduce core inflation.

The strength of the comment that price stability remains a core tenet of monetary policy was dampened by the comment that the ongoing domestic recovery requires continued policy support to make it more widespread.

We continue to anticipate that with the RBI increasing the reverse repo rate by 15 bps in the February policy review, the monetary policy stance will be changed to neutral, provided a third wave does not emerge in the intervening period. While the lift-off, which begins in February, is likely to have eased somewhat, the tone of the policy is less sharp than anticipated. This is manifested in the benchmark 10-year G-Sec yield cooling down by 5bps to 6.34% after the policy announcement.

The RBI governor’s comments on the systematic development of the yield curve in his absence were clearly on the public good. The new benchmark was issued in July at 6.10%. With no cancellations/transfers in G-Sec auctions since mid-August, yields for this security have increased by 25 bps over the past five months, representing a form of stealth tightening.

While the option to deploy normal or twist OMOs is retained, we expect returns to be allowed to adjust to a new normal as we move closer to policy normalization.

In Q4, both fiscal and monetary policy signals will guide the level at which bond yields rise. Markets are now preparing for rapid tapering and rate hikes by the Fed, with inflation no longer being labeled as temporary. As the views of Indian markets on the timing and extent of repo hike by MPC become clear, further tightening of G-Sec yields is inevitable.

With the next policy review to be held after the presentation of the Union Budget for FY 2013, it will become clear whether fiscal policy can support the nurturing and broad-based burden of nascent domestic reform, allowing monetary policy support to be gradually withdrawn. allowed to take. Start.

Ramnath Krishnan is the MD and Group CEO of Icra Limited.