By Deepak Jasani
The MPC voted to raise the repo rate by 50 bps taking it to 5.9% as widely expected while remaining focused on the withdrawal of accommodation. The central bank continued its stance unchanged as “withdrawal of accommodation”. A higher rate hike is justified in the backdrop of inflation remaining at elevated levels with the projected trajectory being above RBI’s target during the entire forecast horizon. Economic growth has remained resilient in the face of an adverse global environment. The recent sharp depreciation in the rupee (although well managed compared to other emerging countries) might have weighed on members’ decision in favour of a larger rate hike, addressing external sector imbalance and reducing the interest rate differential.
The global economic outlook continues to be bleak with financial conditions tightening and recession fears mounting. Central banks are charting new territory with aggressive rate hikes that may lead to softening of growth in the near term. The latest interest rate projections by the Federal Reserve are higher than the previous projections, indicating that the central bank may continue its aggressive monetary tightening cycle in light of inflation trends. Although RBI decisions take US Fed views into account, India has a different set of challenges. While risks to growth are driven by a slowdown in global growth, risks to inflation are more domestic in nature. A weaker currency is likely to feed into imported inflation pressures.
CPI inflation rose to 7% in Aug 2022 compared to 6.71% in July 2022 led mainly by rising food prices. Inflation, however, is still above the tolerance band and shows signs of being so for the first 3 quarters of 2022-23. While globally commodity prices are on a downward trend, volatility in food prices, which has a major share in the CPI basket, continues to pose an upside risk to domestic inflation. Also, improving discretionary demand especially in the services sector could keep core inflation sticky in the near term.
Late recovery in sowing augurs well for the Kharif output. The prospects for the rabi crop are protected by comfortable reservoir levels. Unchanged inflation forecast at 6.7% for FY23 (and 5% in Q1FY24) is reassuring with a high average crude oil price of US$ 100 per barrel considered in this, providing a cushion. Even as inflation seems to have peaked, it still warrants a caution as its trajectory is clouded by uncertainties arising from continuing geopolitical tensions and nervous global financial market sentiments. Calibrated monetary policy action is needed to contain inflationary pressures and anchor inflation expectations.
On the growth front, MPC noted that domestic economic activity remains resilient. Aggregate supply conditions are improving. With the southwest monsoon rainfall 7% above the long period average (LPA) (as on Sept 29) and its spatial distribution spreading to some deficit areas, Kharif sowing has been catching up. Activity in the industry and services sectors remains in expansion mode. Comfortable reservoir levels, improvement in capacity utilisation, and buoyant bank credit expansion are expected to support aggregate demand.
Urban consumption is being lifted by discretionary spending ahead of the festival season and rural demand is gradually improving. Investment demand is also gaining traction, as reflected in rising imports and domestic production of capital goods, steel consumption and cement production. The rate hikes undertaken by the MPC have so far not impacted the growth prospects in a big way. RBI lowered the GDP projection marginally from 7.2% to 7% for FY23. Extended geopolitical tensions, tightening global financial conditions and a possible decline in the external component of aggregate demand can pose downside risks to growth.
Apart from managing the growth-inflation dynamics, RBI seems to be mindful of external sector imbalances. RBI has done a commendable job in containing volatility and ensuring the orderly movement of the rupee through FX reserves. The Governor in his speech highlighted that RBI does not have any fixed exchange rate in mind. It intervenes in the market to curb excessive volatility and anchor expectations.
Overall it was a prudent policy announcement with no negative surprises which is reflected in the impact on the 10-year yield and stock markets. On the FX front, the USD/INR strengthened post the policy announcement. The challenge at hand for the RBI will be to manage the price pressures while ensuring that the economic growth momentum is not adversely impacted. The next stage of response could be calibrated; we expect the terminal repo rate would be 6.25-6.40% by the FY23 end. Any further policy action would be data-dependent.
(Deepak Jasani is the Head of Retail Research at HDFC Securities. Views expressed are the author’s own.)