By Churchil Bhatt
RBI Monetary Policy Meeting: To hike or not to hike? That is the question the Reserve Bank of India (RBI) faces going into this week’s MPC meeting. As for Bond markets, a 25 bps policy rate hike is more or less the consensus view. Markets also expect this to be the last and final policy rate hike in this tightening cycle. In fact, in their forward-looking endeavour, markets expect this peak in policy rate to be followed by a mini rate cut cycle in late FY24. But is there a case for the MPC to deliver a “status quo” policy? And if market is already pricing in peak rates, how much impact will such a policy surprise have on bond yields?
The first and foremost argument in favour of a “status quo” policy comes from the fact that impact of monetary policy actions plays out with a lag. And when it comes to policy rate action, enough has been done already. The RBI has hiked the policy repo rate by 225 bps this year – one of the fastest pace of rate hikes on record. Given that more than 45% Scheduled Commercial Bank loans are now linked to an external market-linked benchmark, the transmission of this policy tightening into lending rates is already underway.
Furthermore, the RBI is not alone in this fight against inflation. Most major global Central Banks have meaningfully tightened financial conditions this year, the impact of which is now beginning to surface in the form of an impending global growth slowdown. Many developed markets are staring at a policy-induced recession – and the question for them is of “when” and not “if”.
While this was true even at the time of December 22 MPC, one element has decisively changed since then. Both US Federal Reserve and European Central Bank have now acknowledged the green shoots of disinflation in their respective economies. They are no longer willing to fight inflation at any cost and instead are veering towards a more traditional, data-dependent approach. If global Central Banks go soft on their rate tightening, it will reduce pressure on the USDINR exchange rate arising from interest rate differential. This, in turn, will allow RBI to pause and assess the impact of its past policy actions.
Now we come to the primary driver of any monetary policy – inflation. December 22 policy rate hike was in the wake of MPC explaining its failure to meet the inflation mandate. Since then, incremental developments on the inflation front have mostly been positive. Headline CPI has moderated from 7.4% in September 22 to 5.7% in December 22, led by a fall in food prices. Base effects remain supportive of lower headline inflation for most of FY24. Additionally, slowing global growth is helping keep commodity prices under check, despite China re-opening. Hence, forward CPI trajectory remains relatively benign with CPI inflation likely to average 5.2% in FY24.
While inflation continues to moderate, it is far from MPC’s target of 4%. Core inflation too remains sticky at around 6%. But the fact remains that inflation has peaked and is headed in the right direction, albeit gradually. Hence, persisting with already tight monetary conditions may suffice in the near term. Furthermore, Inter-bank liquidity is likely to remain tight over the next couple of months owing to seasonal factors. This by itself will incrementally tighten domestic financial conditions temporarily between now and April 23 MPC.
With positive real rates and a falling inflation trajectory, it is safe to conclude that the stance of monetary policy too has more or less reached the neutral territory. Hence this policy, in our view, will be the right time to “retire” the policy stance of “withdrawal of accommodation”. Shifting to a neutral policy stance will give MPC the leeway to deftly manoeuvre the policy trajectory in either direction in a highly uncertain future.
Cycle peaks (and troughs) are notoriously difficult to predict. Hence, markets should not be too concerned with getting the last 25 bps of tightening right. If RBI refrains from hiking rates in this policy, it will also not have to cut rates by the same amount later. After all, one cannot undo what isn’t done. Since market is already pricing in both the immediate hike and the subsequent cut, taken together the two may not lead to a material repricing in bond yields.
(Churchil Bhatt , Executive Vice President & Debt Fund Manager at Kotak Mahindra Life Insurance Company Limited. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)