RBI may delay rate hikes as Omicron might derail economic activity

The strong relation between economic activity and popular mobility indicators suggests that increase in Covid restrictions is likely to hit economic activity in Q4 FY22. HDFC Bank has said that there could be a downside risk to its growth forecast of 6.1 per cent for Q4 FY’22 by 20-30 basis points ( one bps is 0.01 percent).

” The return of uncertainty around growth and inflation due to the spread of the new variant might delay the RBI’s decision to hike the reverse repo rate in February 2022 as well” said Abheek Barua, chief economist at HDFC Bank.

Even though states have announced more restrictions, higher mobility and a rising positivity rate could result in further rise in new cases that could lead to even more restrictions. ” The restrictions could derail the recovery in contact-intensive services in Q1, but global experience suggests a smaller impact than previous waves and a swift growth rebound once cases peak,” said Sonal Varma , chief India economist at Nomura.

The Reserve Bank in its latest financial stability report has flagged concerns on the risks of rising infections. “More recent high-frequency indicators of economic activity suggest some loss of momentum in the third quarter of 2021-22 ” said the latest financial stability. “The pace of the recovery remains uneven across sectors, inflation formation is being subjected to repetitive supply shocks and the outlook is overcast with global risks. Omicron haunts near-term prospects”.

“If risks surrounding the new omicron variant remain, adding to near-term uncertainty, we think MPC members could remain in “wait-and-see” mode at the Feb policy meeting and could delay policy normalization to the April policy meeting ” said Tanvee Gupta Jain economist at UBS Securities

The inflation risks are not abated. Markets estimate consumer inflation to reach the upper end of the target band of 2 to 6 percent for the current quarter. Indian Households too expect inflation to cross double digit levels. Yet the Reserve Bank will be looking at signs of durable recovery. The key policy rates -the benchmark repo rate-the rate at which it lends to banks and the reverse repo rates- the rate at which it borrows from banks, are unchanged at 4 per cent and 3.35 per cent since May 2020. The monetary policy stance too is “accomodative”.

The Reserve Bank is however other liquidity tools to indicate its initiatives towards policy normalisation. Daily System liquidity surplus reduced to Rs 7.6 lakh crore as of end December compared to Rs 9.6 lakh crore at the beginning of Dec 21. ” RBI’s liquidity normalization/adjustment will continue while rate hike expectations could moderate (reverse repo rate hike in February is now uncertain) as Omicron risk looms” Barua said.