By Vivek Iyer
The RBI Governor address on December 7, 2022 was a discussion that was aligned with market expectations. The market expected a rate hike of 35 basis points, and the RBI announced the same. What is interesting is the RBI governor acknowledging that it is aligned with market expectations and also a comment wherein he said that it is open to debate whether alignment to market expectations is good or bad. This statement clearly reflected the underlying thought process of central bank independence which is key to the success of every monetary policy.
Analysis of the RBI Governor’s speech
Why inflation will not go away easily
Financial stability is one of the key objectives of the Reserve Bank of India and it was interesting to see how the global risks still continue to threaten the financial stability from an India standpoint. The Ukraine conflict is far from resolution, the Sino American tussle has impacted geo-political equations globally and this has resulted in stressed supply chains. Stressed supply chains have resulted into de-globalization with many countries exploring near shoring and protectionist measures, to protect their own national interests. The result will be market imperfections which will have an impact on inflation. This is the analysis that also came out of the governor’s speech to justify the thought process of why the inflation risks will not go away globally and thereby will have its cascading impacts on India as well.
The currency risk challenge
The Governor also did mention about the challenges around the second order effects of global inflation, which in our view indicates the RBI’s implicit desire to intervene in the foreign exchange market to keep the exchange rate within a narrow band. Our sense is that the RBI will try to keep the exchange rate between the range of USD / INR rate of 80 to 82. We can expect a lot of liberalization measures around foreign exchange going forward, if the exchange outflows on account of global interest rate hikes spikes beyond the regulatory expectations.
Is the RBI pro growth or not?
Rate hikes have an impact of forcing a slow down in the economic activity. However, the RBI governor expressed the desire to be pro-growth, given that India is a shining bright spot in an otherwise gloomy global economy. The data points on manufacturing PMI and services PMI indicated strong macro-economic fundamentals. This is one of the parts of the RBI’s job, that no one envies – the tight rope that they have to walk while balancing inflation and growth. This is exactly why the RBI would need to continue to keep a close watch on the continuously evolving geo-political landscape and its impact on macro-economic indicators and the second order effects on India – something that the governor also indicated during his speech.
RBI is of the view that inflation and growth are not necessarily conflicting objectives. Containing inflation provides the much-needed price stability which helps businesses make long term decisions and make sustainable investment plans. This is demonstrated by the fact that the investment numbers have been on an upswing despite inflationary circumstances. Inflation is not a challenge, but letting inflation continue on its riot is a challenge, which is something that is not happening.
Liquidity support will be provided by the RBI as and when needed, to counter the impact that rate hikes may have on the liquidity in the market. The RBI Governor however, mentioned that they will look for markers to identify structural liquidity issues which will demand their intervention and only post that intervene. This in our view is a positive statement signifying the importance of growth in the market.
While the RBI has made additional declarations on a couple of initiatives, what stood out was the domestic players being allowed to hedge gold with IFSC exchanges and UPI related measures. RBI is on the right path and it is imperative that the wait and watch approach of the RBI should continue, so that the policy choices can be directionally beneficial from a financial stability standpoint.
(By Vivek Iyer, Partner and Leader, Financial Services Risk, Grant Thornton Bharat. Views are author’s own.)