While there is still room for the Reserve Bank of India (RBI) to maintain an easing bias due to some retreat in headline inflation recently, we believe the central bank will start to hint at a change of stance as economic growth continues to hold up and oil price gains reflect upside risks to inflation.
Economic recovery is showing some signs of slowing from the peaks seen in the post-COVID phase, amid a stronger base as well as waning of the pent-up demand. Nonetheless, India has so far avoided a third wave of the virus and the approaching festival season is likely to bring a further spurt in consumption levels. Meanwhile, vaccination levels have picked up though not sufficient to still completely rule out further pandemic outbreaks. But we believe that with the experience of the second wave and improved vaccination coverage, any further outbreaks will continue to be handled by more targeted lockdowns, thereby reducing the impact on GDP growth trajectory.
Headline inflation, meanwhile, despite being softer in recent months, continues to face upside pressures. Global supply chain disruptions are likely to extend into 2022, and further oil price gains are also on cards which together with high fuel taxes in India, are fuelling fears depressing demand and feeding inflationary pressures. There are also fears of a China-like energy crunch in India due to its over-reliance on coal. One of the MPC members already voted for a change in stance at the August meeting, and we believe more dissents may be likely in the coming months.
Lastly, fiscal support may be dwindling as the government aims to keep a lid on additional borrowing. But revenue collections are picking up and targeted measures remain likely if further economic headwinds are seen.
Therefore, we expect RBI to keep its repo rate unchanged at 4.00% and reverse repo rate at 3.35% at the October 8 meeting, and the central bank will likely start to unwind the surplus liquidity from end-2021. More meaningful tapering will only likely occur in H1 2022 when growth recovers more durably, and rate hikes are likely to follow in H2 2022.