The Reserve Bank of India (RBI) has left the interest rates untouched for the tenth time in a row, hinting that its accommodative stance would be prolonged and a reversal would be very gradual to support growth in the economy.

Justifying its stance at a time when central banks across the globe are looking at hardening rates to control inflation, the RBI on Thursday said the Omicron is slowing global growth and India is no exception and inflationary pressures would ease.

The repo rate, the key signaling rate of the RBI, remains at 4% while the reverse repo rate is unchanged at 3.35%. The Marginal Standing Facility (MSF) rate and bank rate also remained unchanged at 4.25%.

"Monetary policy has to be supportive to ensure growth is sustainable," RBI governor Shaktikanta Das said. “Domestic economic activity is yet to be broad-based as private consumption and contact-intensive services remain below pre-pandemic levels.”

The RBI surprised the market with a policy statement that has a lower GDP at 7.8% and an inflation forecast at 4.5% for FY23.

Das said the central bank has done its homework on inflation and all uncomfortable risks have been duly assessed before arriving at 4.5% projection for CPI inflation in FY23. "The character of inflation in other major economies is somewhat different from India," the RBI Governor added.

The Bank of England recently raised its short-term interest rate by 0.5%, while the Federal Reserve is looking at a 0.25% raise when it meets in early March. The European Central Bank (ECB) is also talking of a rate hike, going back on its earlier stance that it may not hike rates in 2022.

 “The MPC (Monetary Policy Committee) has decided to continue the accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward,” the RBI said in a statement

The RBI has taken three bets in its quest for a lower term structure of interest rates, according to State Bank of India (SBI) chief economic adviser Soumya Kanti Ghosh. They are crude prices, US yield and the government borrowing programme that determine yield trajectory will largely be under control. 

“While crude price increase may have bottomed out, the US yields might soften today on the back of lower-than-expected inflation print. The third and the largest elephant in the room is the size of government borrowing programme. We expect for FY23, the government has budgeted net market borrowing of Rs 11.2 lakh crore. That, however, could be lower by at least Rs 2.5 lakh crore, Ghosh said in a report.

The RBI said it expects the CPI (consumer price index) inflation to soften with strong supply-side interventions by the government and prospects of a good rabi crop adding to the optimism on the food price front.

“Going forward, vegetables prices are expected to ease further on fresh winter crop arrivals. The softening in pulses and edible oil prices is likely to continue in response to strong supply-side interventions by the government and increase in domestic production,” RBI said.

The lower inflation projection took the market by surprise with the 10-year yield falling by 10 basis points, and expectation is that it would decline further. 

Yields moderated post the RBI monetary policy announcement. The 10-year yield eased to 6.72% and was trading at 6.712%  as compared to 6.80% yesterday. Market expects the 10-year yield to trade in the range of 6.70-6.85% by the end of March and in the range of 6.85-7% by the end of June.

 “This was the first policy of the calendar year and perhaps sets the tone for the rest of the year. The RBI’s projections show that inflation is on a downward trajectory. Were that indeed the case, the RBI is likely to follow a more gentle approach to the normalisation and untimely withdrawal of monetary support unlike the Western central banks that have switched to a hyper-aggressive mode. This is consonant with the growth and inflation dynamics specific to India,” HDFC Bank chief economist Abheek Barua said.

Retail inflation has been a matter of concern as it surged to a five-month high of 5.59% in December from 4.91% in November, mainly due to an uptick in food prices. The MPC has been given the mandate to maintain annual inflation at 4% until March 31, 2026, with an upper tolerance of 6% and a lower tolerance of 2%.

The outlook for crude oil prices is rendered uncertain by geopolitical developments even as supply conditions are expected to turn more favourable during 2022.  While cost-push pressures on core inflation may continue in the near term, the Reserve Bank survey points to some softening in the pace of increase in selling prices by the manufacturing and services firms going forward, reflecting subdued pass-through.

“The surprise element in the credit policy is the very dovish stance taken by the MPC, which in a way supports the expected large government borrowing programme as well as the corporates that will be borrowing funds this year. The take on inflation is fairly aggressive for FY23 as the forecast of 4.5% assumes that the oil economy remains stable, which is probably the biggest risk today. The forecast for growth is slightly less sanguine than the government, which forms the basis for taking a rather conservative view on the durability of growth. This all means that the indication is that as of now it looks like the repo rate will not be increased in FY23 unless the numbers turn really adverse,” said Bank of Baroda chief economist Madan Sabnavis. 

The RBI’s bi-monthly policy comes close on the heels of the budget which projected India’s nominal GDP to grow by 11.1% in 2022-23. The government expects this growth to be ignited by its massive rise in capital expenditure for the next financial year.

Finance Minister Nirmala Sitharaman has proposed a 35.4% increase in capital expenditure for the financial year 2022-23 to Rs 7.5 lakh crore to continue the public investment-led recovery from the pandemic-battered economy. The capex in the current financial year is pegged at Rs 5.5 lakh crore.