As Omicron creates economic uncertainty and casts a shadow over growth, RBI keeps interest rates unchanged

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) opted to maintain the status quo in its December meeting, as expected. The committee opted to hold the benchmark policy repo rate at 4% and maintain its accommodative posture “as long as required” to help the economy thrive. The tone of the statement was cautious and more dovish than expected due to the uncertainty surrounding the new Covid version. The central message of the statement, however, remains the same: “continued policy support is warranted” as long as inflation remains under control, and given “the slack in the economy” and the fact that parts of the economy, particularly private consumption, are below pre-pandemic levels, “continued policy support is warranted.”

The MPC feels that economic activity is gaining traction, saying that “domestic economic activity recovery is becoming increasingly broad-based.” The central bank has kept its growth prediction for this year at 9.5 percent. However, due to slightly higher-than-expected growth in the second quarter, potentially due to pent-up demand, it has cut its second-half growth prediction. The third and fourth quarter forecasts have been lowered to 6.6 percent and 6%, respectively, from 6.8 percent and 6.1 percent earlier. Despite the central bank’s prediction for solid growth in the first half of the fiscal year, concerns about domestic demand and private investments linger.

The Governor’s statements on “managing a lasting, strong, and inclusive recovery,” as some economists have pointed out, show ongoing concerns about the economy’s unequal nature. The committee has maintained its full-year inflation forecast of 5.3 percent for 2021-22. (with some changes to the third and fourth quarter estimates). While the committee is concerned about the continuing of strong core inflation, it will be comforted by the significant reductions in excise tax and VAT on gasoline and diesel, which have reduced retail prices. This will have “second-round consequences over time,” according to the MPC.

The policy pivot’s next phases, in addition to normalising liquidity, involve raising the reserve repo, reversing the accommodative posture, and eventually rising the repo rate. The dates for these phases are currently unpredictable due to the Omicron variant and altering growth-inflation dynamics. The MPC should continue with prudence, rely on evidence, and calibrate its next measures carefully, given the uneven nature of the economic recovery.

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