By Suvodeep Rakshit
The science of monetary policy making dictates that a central bank, in most cases, can decide on its move objectively based on the data available. Typically, most part of the rate hike or cut cycle is predicated on this science. However, the end of the cycle is much more nuanced. The data signals, while important, needs to be mixed with a bit of belief and experience, especially in an environment of uncertainty. The RBI might be finding itself in such a phase with every policy expected to be the end of the RBI’s rate hike cycle.
The RBI MPC will go into the policy meeting with January and February inflation prints closer to 6.5% — reversing from the sub-6% prints of November and December. Importantly, core inflation remained above 6%. The MPC in the last policy was hawkish and had shown significant concerns on core inflation front. In fact, the 4QFY23 headline inflation likely at around 6.2% will be 50 bps higher than the RBI’s estimate in the February policy. Along with this, the domestic growth scenario has not disappointed yet though there has been some weakness in discretionary consumption post the festive season in early-3QFY23.
This current situation can be coupled with the inflation trajectory over the next one year which is unlikely to fall below the 5% mark (barring couple of months of in 1QFY24). Further, the global central banks are not signaling any pivot. The markets have continued to be proven wrong for quite some time. Currently, the Fed stands pat at 5-5.25% range by end-CY2023 in a bid to bring back inflation gradually towards the target while the market expects 75 bps of rate cuts by December 2023. The Fed’s stance has been maintained at a time when the global markets were roiled by the US regional banks crisis and Credit Suisse sale. The ECB’s and the Fed’s policy decisions have clearly highlighted that the tools for inflation targeting (through monetary policy) and financial stability (through liquidity injection) will be kept separate — possibly until either the real economy enters a recession or the financial sector sees significant stress.
The science of it all would indicate that the RBI needs to follow a similar route given the domestic inflation-growth dynamics and global central banks’ policy rate signals. But the art of policy making would ask a different question. How high a policy rate is high enough, especially for the RBI? Based on the forward-looking inflation trajectory, at an average of around 5.5% in FY2024, the repo rate at 6.5% would yield real rate of around 100 bps. An RBI staff paper in June 2022 had estimated the natural rate of interest at 0.8-1% for 3QFY22. RBI MPC member, Dr Ashima Goyal, had observed in the February policy meeting minutes that “a real repo rate of around unity suits the current stage of the cycle”.
Coupled with this, the system liquidity is due to tighten further, possibly to deficit on a durable basis, by end-April as the pandemic period LTROs are wound up. A tight liquidity coupled with a positive real repo rate provides scope for the RBI to pause and watch for the past policy tightening as well as the global macro conditions pass-through the domestic economy. Reaching the inflation target of 4% over the next year or so is unlikely. However, keeping monetary conditions adequately tight and along with some government interventions, inflation can glide towards the 4-4.5% mark without much scarring to the growth trajectory.
For the April policy, the science and the art of policy making should blend. The RBI should follow up on its hawkish stance and ensure that real policy rates remain in a restrictive zone. A 25 bps hike to take repo rate to 6.75% should achieve that in conjunction with a tightening of system liquidity. But the MPC should also dovetail it with a shift in stance to neutral. This would signal that it retains the flexibility to act in either direction, as necessary, while letting the economy absorb the past rate hikes and observing for any impact on the domestic economy from the incipient stresses in the global macro.
(Suvodeep Rakshit is Chief Economist in Kotak Institutional Equities. Views expressed are personal.)