RBI MPC: Future rate hikes to depend upon how soon RBI wishes to bring medium-term inflation back to 4%

Depending on which market one looks at, the world economy is simultaneously avoiding and approaching a recession.

RBI, RBI MPC
Policy rates are probably the only thing to have near-normalized in this otherwise abnormal era.

By Churchil Bhatt 

Depending on which market one looks at, the world economy is simultaneously avoiding and approaching a recession. Some may find this analogous to the celebrated Schrodinger’s Cat, which can be both dead and alive at the same time. Can monetary policy too, be both accommodative enough to allow for high inflation yet tight enough to cause an economic recession? Global financial conditions seem sufficiently tight if one looks at recent run of policy rate hikes, but also adequately loose when one looks at the quantity of money available in the economies. 

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Policy rates are probably the only thing to have near-normalized in this otherwise abnormal era. While Central Banks across continents appear to be fighting inflation with rate hikes, upon closer inspection, we find an ulterior motive underpinning each action. The US Federal Reserve is essentially trying to regain its inflation fighting credibility, hard-earned over the last 40 years. The ECB and BoE are fighting for their economic survival amidst somebody else’s war. In what may be dubbed as almost a self-goal, China’s economic policies are primarily battling China’s Covid policies. Finally, there is a good chance that the Bank of Japan does not even remember why or what it is fighting for. 

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Sitting in India, we tend to underappreciated how uncertain and volatile the world continues to be. In comparison to most economies, India has done remarkably well to handle plethora of six sigma challenges. While economies world over are overpaying for the excesses of their pandemic-support measures, India is merely tackling import-led inflation with minimal growth sacrifice. This is a testimony to the deft and nimble navigation by our policy makers during these times of extreme uncertainty. 

In a widely expected move, the MPC today hiked the policy rates by 50 bps and continued its focus on withdrawal of accommodation. The MPC is optimistic on India’s growth prospects, and has kept the FY23 GDP growth projection unchanged at 7.2%. Despite the correction in global commodity prices, the MPC also kept its FY23 CPI forecast unchanged at 6.7% citing the geopolitical uncertainty. 

With continuing focus on withdrawal of accommodation, we expect further future rate actions.  The quantum and pace of future rate hikes will depend upon how soon RBI wishes to bring medium-term inflation back to 4% target. In our view, for as long as the trajectory of inflation continues its downward journey, the MPC will adopt a gradual approach to its future policy adjustments. In contrast to front-loaded rate actions, liquidity normalization will continue at a leisurely pace and will spill over into FY24. Given the recessionary global backdrop and its disinflationary impulse, we believe that the policy repo rate in India should peak around 5.75%. 

The expectation that the global inflation will peak soon is emanating from the fact that policy tightening has induced a demand slowdown. This is akin to merely addressing the symptom. Governments and policy makers will have to work towards augmenting commodity production, resolving tough geopolitical issues and gradually removing trade barriers to address the root cause of inflation. Resolving these issues will take many years, and in the interim, any sharp growth impulse will necessarily be inflationary. Policy makers will therefore be pushed to keep rates higher for longer. Additionally, higher policy rates have to also compensate for unhurried withdrawal of excess money from the system. Hence, even if inflation peaks, prospects for broad-based, non-inflationary growth rebound remain low. Dear Global Growth, Winter is coming.

(Churchil Bhatt, Executive Vice President, Debt Investments at Kotak Mahindra Life Insurance Company. Views expressed are the author’s own.)

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