NEW DELHI: Caught between weak growth and inflation above the mandated band of 2-6 per cent, the Reserve Bank of India (RBI) has been left with little choice but to distance itself from an accommodative policy. But, economists say that the start of policy normalisation will remain contingent on a sustained growth recovery, evidence of which is unlikely to be visible before the end of the current fiscal year. The central bank is expected to hike the repo rate only by the first quarter of next fiscal (April-June 2022).
“While a gradual recovery is again taking hold, growth remains far below potential, with the output gap still deeply negative. The transmission of past policy cuts is also still not complete. Our ‘Taylor rule’ estimates rule out rate hikes in FY22, and we see room for a repo rate hike only in Q1FY23,” said Barclays’ chief India economist Rahul Bajoria on Tuesday.
Currently, the repo rate stands at 4 per cent with the reverse repo rate at 3.35 per cent—the lowest repo rate since 2000. The central bank has slashed repo rate by 115 basis points (bps) since the outbreak of the pandemic in March 2020 and has found itself in a bind every since. While the first lockdown constricted supply and demand for much of Q1 of the last fiscal, pushing the economy into a record 24.4 per cent contraction during April-June and causing full-year GDP to shrink 7.3 per cent, the second wave has crushed all-round demand and consumer confidence.
It is to be noted that after responding with deep rate cuts initially, the RBI has limited itself to using non-conventional tools to help growth. However, with the recent surge in retail inflation (at 6.3 per cent in May), there have been questions raised over this. “Given this backdrop, we expect the central bank to maintain its accommodative stance, and to continue to rely on the government’s supply-side measures to reign in price pressures, while at the same time confirming its commitment to anchoring medium-term inflation expectations,” Bajoria added.
The ineffectiveness of the Centre’s supply-side measures, an un-anchoring of inflation expectations leading to a wage-price spiral, and a return of pricing power are some of the key triggers that could force the RBI into rate action earlier than expected, he said. The brokerage expects inflation to be at 5.4 per cent for FY22.