The Reserve Bank of India sends dovish signals

In recent weeks, markets had begun to price in—prematurely, in our view—the likelihood that the Reserve Bank of India (RBI) could begin to tighten monetary policy soon. As such, the RBI’s dovish comments following a widely expected decision to leave interest rates unchanged last week surprised some investors. However, it’s a development that could bode well for India’s economy and revive foreign interest in Indian assets.

In aggregate terms, capital flows into emerging markets (EM) have been subdued following a meaningful retracement from November. In fact, flows have come under pressure amid a less-supportive U.S. dollar backdrop; rising U.S. Treasury yields, which has the net effect of compressing interest-rate spreads between EM economies and the United States; setbacks in containing COVID-19; and escalating geopolitical tensions/idiosyncratic risk. This has prompted several central banks in the EM universe (Russia, Turkey, Brazil, and South Africa) to hike policy rates/turn more hawkish in recent weeks. Markets had been quick to extrapolate this trend to other EM central banks, including the RBI. As it turns out, such expectations proved to be misplaced.

RBI: transparent and credible statements

"Whatever it takes"—three words that once signaled former European Central Bank President Mario Draghi’s commitment to maintaining an accommodative monetary policy stance for as long as necessary to secure economic recovery—can be found in RBI Governor Shaktikanta Das’s statement on April 7.¹

In a nutshell, the RBI formalized its quantitative easing program, pledging to buy up to one trillion Indian rupees’ worth of bonds in the current quarter to keep borrowing costs down. This announcement is significant because it’s the first time the central bank has placed a figure on its bond purchasing program. The RBI also extended its on-tap targeted long-term repo operations scheme by six months to ensure there’s enough liquidity to support the economy during the period.¹ In our view, the RBI’s message to the markets couldn’t be clearer.

The macroeconomic context

The yield curve of Indian government bonds has shifted higher in recent months² despite the introduction of multiple liquidity measures and assurances from the RBI that it wasn’t in a hurry to normalize monetary policy. Meanwhile, the central bank’s upbeat outlook in February has already been superseded by the latest developments: High-frequency indicators showed that domestic demand remains anemic as new COVID-19 infections continue to rise across key states while external demand weakened due to the strength of the rupee. Crucially, the recovery in corporate borrowing stalled as the belly of the yield curve (Indian government bonds with medium-term maturities) bore the brunt of the global bond market sell-off.

3- and 5-year Indian government bonds have borne the brunt of the rising yields since January 1

Source: Clearing Corporation of India, Macrobond, Manulife Investment Management, as of April 6, 2021.

In our view, the RBI had policy room to take a more dovish stand and needed to do so. Even though India’s headline Consumer Price Index inflation rebounded from 4.1% to 5.0% in February on a year-over-year basis,² the recent fall in household inflation expectations suggests underlying price pressures in the country will be contained and inflation should stay below the RBI’s 6.0% upper limit. Besides, India is much less externally vulnerable relative to any point in the past decade—specifically, relative to 2013’s taper tantrum. Crucially, India’s current account moved into a small surplus in Q4 2020, and net direct investment inflow has risen to the highest on record while its reliance on “hot money” is much reduced.

That said, India’s recovery is still fragile, and the RBI’s rate-setting committee will likely be very wary of withdrawing policy support too soon. In its recent state of the economy report, the central bank said, “there is no way the economy can withstand higher interest rates in its current state. It is recovering, but certainly not out of the woods yet.”³ We agree.

India’s economy is relatively less vulnerable to external factors

Source: RBI, Macrobond, Manulife Investment Management, as of April 8, 2021. LHS refers to left-hand side; RHS refers to right-hand side.

Focusing on growth

Indian equities have underperformed broader EM since mid-February as net foreign investment inflow has slowed.² Foreign flows into Indian bonds have recovered recently but remain in negative territory.⁴ A firm commitment by the RBI to maintain an accommodative monetary policy stance for an extended period on the back of a  historically expansionary Union Budget should leave no doubt that monetary policy is working with fiscal policy to secure India’s future growth potential and help to revive foreign investor appetite for Indian assets.

In our view, India’s future growth potential can be attributed to the following factors:

  • India continues to be one of the fastest-growing economies in the world. (The International Monetary Fund projects a growth rate of 11.5% in 2021.)⁵

  • By 2030, India is projected to be one of the world’s largest economies (measured by market exchange rates).⁶

  • The government’s Make in India policy is focused on self-reliance and building up domestic industry to lift the share of manufacturing in GDP from 17.0% currently to 25.0% over the medium term⁷; India is emerging as an alternate manufacturing investment destination.

  • Labor costs in India remain competitive.

  • Demographic advantage—approximately half of its population is aged under 25, and India will continue to have one of the youngest populations in the world until 2030.⁸

  • Average household incomes are forecast to triple over the next two decades and it’s one of the fastest-growing affluent populations; India is forecast to be the world's fifth-largest consumer economy by the year 2025.⁶

  • India is relatively insulated from geopolitical tension that could disrupt supply chains given its relatively lower exposure to external demand (exports represent ~10.0% of GDP⁴) and has much higher domestic demand-driven growth.

  • There's a possible global bond index inclusion in the future, which would attract greater capital inflows.


In our view, the RBI is right to decide against going down the path of policy normalization as several of its EM peers have done. While uncertainty remains, by strengthening its commitment to accommodative monetary policy through transparency and clear communication, the central bank has laid the foundation for what could be a strong economic recovery in India.  

1 Governor’s Statement,” Reserve Bank of India, April 7, 2021. 2 Bloomberg, as of April 6, 2021. 3 RBI BULLETIN: State of the Economy,” Reserve Bank of India, March 19, 2021. 4 Reserve Bank of India, Macrobond, as of April 6, 2021. 5 World Economic Outlook Update,”, January 26, 2021. 6 World Economic League Table 2021,” Centre for Business Economics and Research, December 2020. 7, March 2021. 8 UNFPA India, March 2021.

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Sue Trinh

Sue Trinh, 

Senior Macro Strategist

Manulife Investment Management

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