The Monetary Policy Committee (MPC) which met in the first week of April 2022, assessed the macroeconomic situation and unanimously voted to keep the policy repo rate unchanged at 4 %. They decided to maintain an accommodative stance simultaneously focusing on withdrawal of accommodation. This is to make sure that inflation remains within the target, while also supporting growth. The marginal standing facility rate and the Bank rate have been unchanged at 4.25 %. The Reserve Bank has also decided to restore the width of the Liquidity Adjustment Facility (LAF) corridor to 50 basis points, matching the pre-pandemic numbers. The floor of the corridor will now be placed 25 basis points below the repo rate at 3.75 % as provided by the newly instituted standing deposit facility.
The Monetary Policy Committee held on to an accommodative stance mainly due to the sharp escalation in geopolitical tensions which have adversely impacted the external and domestic landscape. The two economies engaged in war have been the biggest contributors of global production and exports of key commodities like oil and natural gas, which has caused supply disruptions in the commodity and financial markets. Global crude oil prices crossed US$ 130 per barrel, which is their highest level since 2008. They still remain volatile at these levels, despite some correction. Food and commodity prices have also hardened globally. There have been large capital outflows from emerging market economies which has further led to depreciating currencies. All these factors have led to an increase in the global inflation projections, which have already been above targets in all major countries. They have also adversely impacted the outputs across most geographies.
All advanced economies have been affected by the recent geopolitical tensions, a sharp rise in inflation and consequent monetary policy normalisation. Consequently, the supply chain disruptions and input cost pressures will go on for a longer period of time. The re-emergence of COVID-19 infections and the resultant lockdowns can further aggravate the global supply bottlenecks and input cost pressures. The output, world trade and demand are likely to be weaker than anticipated few months ago. Although the economic activity is resuming and recovering, it is not above its pre-pandemic level. Considering all these factors, the Monetary Policy Committee decided to retain the repo rate at 4 %.
Assessing Growth and Inflation
The real GDP rose by 8.9 % in 2021-22 as per the estimates released by the National Statistical Office (NSO) on February 28, 2022. However, the two key drivers of domestic demand, private consumption and fixed investment remained muted. They were only 1.2 % and 2.6 % above their pre-pandemic levels, respectively. On the supply side, services which are contact-intensive, are still at their 2019-20 levels. Nonetheless, the Indian economy is slowly but steadily recovering from its pandemic induced negative aftermath.
The weakness in economic activity re-appeared in the third quarter of 2021-2022. It was intensified by the arrival of the Omicron variant in January 2022. A turnaround was noticed in February 2022, however, in March 2022 it was quite mixed. Due to declining infections and withdrawal of restrictions, contact-intensive activities have been recovering. Economic indicators such as GST collections, toll collections, fuel consumption, and imports of capital goods posted robust year-on-year numbers and expansion during the months of February and March. Even the domestic air passenger traffic improved in March after restrictions were eased. Revival in the economic activity has led to increased consumer confidence. However, the sale of passenger vehicle sales contracted. In the month of March, manufacturing PMI ebbed slightly, but the services PMI showed improvement.
Taking rural demand into consideration, a good Rabi output should support its recovery. Improvement in contact-intensive services should also help in strengthening the urban demand. With a pick-up in bank credit and support from government capital expenditure, even the investment activity should gain traction.
The geopolitical tensions have subdued the economic outlook. The war could slow down the economic recovery process by way of inflated commodity prices and global spill over channels. The financial market volatility and the new COVID-19 variants can create supply-side disruptions. The shortages in inputs such as semi-conductors and chips can also give rise to a negative economic outlook. Taking into account all these factors, the real GDP growth for 2022-23 is projected at 7.2 % with the first quarter at 16.2 %, second quarter at 6.2 %, third quarter at 4.1 %, and the fourth quarter at 4.0 %.
The spur in crude oil prices since February gives rise to increase in inflation through direct and indirect ways. An increase in domestic pump prices could lead to a second round of price pressures. A spike in international commodity prices along with major logistic disruptions could further lead to increased input costs across all the sectors. An efficient supply management is necessary to avoid their pass-through to retail prices. Considering all the above factors and assuming a normal monsoon in 2022, and average crude oil price of US $ 100 per barrel, the Monetary Policy Committee has projected inflation at 5.7 % in 2022-23, with the first quarter at 6.3 %, the second quarter at 5.8 %, the third quarter at 5.4 %, and the fourth quarter at 5.1 %.
Liquidity and Financial Market Conditions
Since the macroeconomic scenario is experiencing numerous changes, the policy needs to be fine-tuned in response to the dynamic situations. Currently, liquidity management is characterised by two-way operations, being:
- variable rate reverse repo (VRRR) auctions to absorb the prevalent liquidity
- variable rate repo (VRR) auctions to meet temporary shortages in liquidity and to nullify any mismatches thereof
- The Monetary Policy Committee will restore the liquidity management framework which was instituted in February 2020 with the following changes:
- The Reserve Bank introduced the Standing Deposit Facility (SDF) empowered by the amendment to Section 17 of the RBI Act in 2018. The SDF strengthens the operating framework of monetary policy by removing the binding collateral constraint on the central bank. Hence, the SDF has been introduced as the floor of the LAF corridor. The introduction of a standing absorption facility at the bottom of the LAF corridor would provide a symmetry to the operating framework of monetary policy. Thus, at both the ends of the LAF corridor, there will be standing facilities. One to absorb the liquidity and the other to inject liquidity. The banks will have the authority to give access to SDF and MSF. But the access to repo/ reverse repo, OMO and CRR will be available at the discretion of the Reserve Bank only.
- The SDF rate will be 25 bps below the policy rate, and will be applicable to overnight deposits. However, it can absorb liquidity of longer tenors when required. The MSF rate will be the same, that is, 25 bps above the policy repo rate. Thus, the width of the LAF corridor is restored to the pre-pandemic levels of 50 bps.
- The fixed rate reverse repo (FRRR) rate is retained at 3.35 %. The FRRR along with the SDF will give flexibility to the RBI’s liquidity management framework.
- Both MSF and SDF will be available throughout the year, on all days of the week.
- The opening time for financial markets regulated by the RBI has been changed to the pre-pandemic timing of 9:00 am with effect from April 18, 2022. However, the closing time of the markets will remain the same.