India: RBI unlikely to rock the (policy) boat


RBI MPC is likely to draw confidence from the turnaround in recent data but express caution over a potential third Covid wave.
Radhika Rao30 Jul 2021
  • The RBI monetary policy committee will adopt a wait-and-watch mode in August
  • Policy commentary is likely to draw confidence from the turnaround in recent data
  • … but express caution over a potential third Covid wave
  • An upward revision in forecasts is possible to demonstrate inflation concerns
Photo credit: Unsplash


Uncertain economic outlook to dominate the narrative

The Reserve Bank of India monetary policy committee (MPC) will decide on rates on August 6th. Since the last rate review in June, policymakers have had two months’ of inflation prints on hand and a host of high-frequency indicators that signal that the economic momentum has largely recovered from the slump caused by the second wave of the pandemic.

The latest monthly RBI bulletin reflects this confidence yet flags few risks. Hastened vaccination rollout, a turnaround in activity indicators, and buoyant agricultural output (if monsoon catches up) are reasons to remain upbeat. However, a slower improvement in aggregate demand and lagged reopening of services sector activity tempered optimism. Risks of a third pandemic wave and its impact also cloud the horizon. An RBI staff study (not the central bank’s official forecast) pegged the Economic Activity Index for the June quarter GDP growth forecast at 22% y/y, slightly firmer than the MPC’s official forecast and our GDP Nowcasting model. The firmer EAI is unlikely to lead to any reassessment in the annual estimates for FY22 growth, which was last adjusted down by 100bps in June to 9.5% y/y (DBSf: 9.5% y/y).




Watch the tone on inflation after CPI inflation held firm at 6.3% y/y for a second month in June. Notwithstanding these elevated prints, RBI Governor Das had recently emphasised that inflation was still largely supply-driven, referring to it as a temporary hump and expecting it to moderate by late-2021. Given the nature of this transitory rise, he saw the need for government intervention to contain inflation, presumably via a reduction in fuel taxes, easing controls on food imports, etc. Minutes from the June meeting also saw few MPC members echo the Governor’s views; they took comfort that inflation was primarily between the target range and predominantly cost-push driven. Others were wary over rising inflation and preferred to normalize policy gears earlier if not for the pandemic-led uncertainty.

Inflationary expectations continued to inch up, fuelled by higher input costs, exogenous factors (e.g., commodities, logistics costs), a spurt in retail fuel prices, and a reopening premium (goods to services inflation).



Expect the MPC to dial up its FY22 inflation forecast from the present 5.1% y/y. Headline CPI inflation has stayed above the 4% target midpoint for 21 consecutive months and above the 6% tolerance band for more than half of that period. We expect price pressures to moderate for the rest of 2021 and bounce in the March 2022 quarter. Our CPI inflation forecast for FY22 is 5.5%.

Forward guidance

The RBI MPC is unlikely to rock the (policy) boat in August, opting to keep the repo rate at 4% and the policy corridor unchanged. Forward guidance will favour a continuation of the accommodative policy stance to guard against growth risks, especially the third Covid wave. The accompanying commentary will heed inflation risks through close monitoring and refrain from tweaking the policy levers for now.



The preference to gradually draw out excess liquidity might increase the sizes of variable reverse repo rate auctions while reaffirming support for the ongoing G-SAP program. The impact of a VRRR increase might be marginal given the scale of surplus liquidity (estimated at INR7.5-8trn) – bank liquidity plus government cash balances. Nonetheless, it affirms the central bank’s intent to mop up liquidity at a calibrated pace before setting the stage for a reverse repo increase and change in policy stance around the end of 2021 or early 2022.

Global factors might find a mention but are unlikely to be catalysts for domestic price action. At the recent FOMC, US Fed Chair Powell indicated that officials had taken a “deep dive” on how to go about scaling back bond buying but no concrete decision has been made. This comes just as market watchers weigh the impact of the current US COVID-19 wave on US economic growth.

Accelerated usage of digital payment channels

Growth of digital payments have accelerated in India, driven by both supply (availability of platforms) and demand (growing consumer appetite). In the past five years, demonetisation (November 2016), followed by the Goods and Services Tax (GST) rollout in July 2017 and COVID-19 outbreak, can be viewed as event-based catalysts that hastened the shift towards digital payments. The pandemic provided the nudge towards digital payments for retail transactions, fuelled by movement restrictions and fear of handling physical notes (on hygiene grounds). Value and volume of electronic fund transfers from banks rebounded sharply amidst a gradual lifting of the nationwide lockdown.



With the pandemic situation far from fully resolved, this shift towards digital channels is likely to be more enduring than the earlier bouts. Recently, the RBI introduced a Digital Payment index based on five parameters a) payment enablers (weight 25%); b) payment infrastructure – demand-side factors (10%), c) payment infrastructure – supply-side factors (15%), d) payment performance (45%) and (e) consumer centricity (5%). With Mar18 as a base year, the DPI index has recorded a strong pick-up, up 24% q/q and 30% y/y in Mar21.

To read the full report, click here to Download the PDF.

Radhika Rao

Economist – India, Indonesia, Thailand & Eurozone
[email protected]


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