With US Fed tightening imminent, RBI must normalise policy and hike rates, or risk capital flight overseas

RBI is expected to follow global cues and increase interest rates, though it’s not clear when it will do so. Some experts expect RBI to take global cues and act soon, others say it will wait and watch.

RBI's MPC is set to meet next in February. (File Photo: Reuters)

With the US Federal Reserve taking an aggressive stance towards its monetary policy and eyeing interest rate hikes this year, the Reserve Bank of India too will soon have to look at normalising domestic policy, or else India may see foreign capital flowing out. RBI is expected to follow global cues and increase interest rates, though it’s not clear when it will do so. Some experts expect RBI to take global cues and act soon, others say it will wait and watch. The US Fed is expected to raise interest rates sooner than expected and begin reducing its overall asset holdings, according to the minutes of the December Fed meeting released last week.

RBI monetary policy rate hikes: When and how much

“General expectation is once there is upward movement in domestic interest rates, we expect four to six rounds of hikes. It could be 100 to 150 basis points. But that actually depends on how inflation is going to be. If foreign inflation, ie inflation in the industrial world, becomes very sticky and stays for a long time then you might see more than 100 basis points hike in interest rates…,” NR Bhanumurthy, economist and Vice Chancellor, Dr BR Ambedkar School of Economics University said. Asked about when the rate hikes could be, he said, it is difficult to predict if the hikes will be in the calendar year or financial year.

As and when RBI decides to hike interest rates, one should expect the interest rate cycle, which goes up to 100 to 150 bps, Bhanumurthy added. Upasna Bhardwaj, Senior Economist at Kotak Mahindra Bank, said she expects RBI to hike repo rate as early as August and reverse repo rate during February-April. She sees a 50 basis points increase in repo rate by the end of the FY2023, while a 90 basis points raise in reverse repo rate.

On the other hand, Madhavi Arora, Lead Economist at Emkay Global Financial Services, said she does not expect RBI to aggressively react to Fed actions, adding that she sees a reverse repo rate hike but not until April.

India needs aggressive monetary policy normalisation, or money will move overseas

It is about time India has to be aggressive in its policy normalisation and follow global cues, Kotak’s Bhardwaj told Financial Express Online. “If India will not act in terms of policy normalisation there is clearly a risk of FPI outflow, the interest rate differentials will narrow and that could cause some financial instability. It is about time, India will have to be much more aggressive in its policy normalisation and follow global cues,” she added.

When the US Fed takes a hawkish stance, historically it has been seen that it impacts emerging markets. If there is foreign interest rate hike, it is expected that there could be foreign capital outflow, Bhanumurthy, economist and Vice Chancellor said. Foreign capital inflow and outflow is decided by interest rates differentials; if interest rate differential is in favour of foreign currency, then you expect them to shift to foreign currency, and vice-versa, Bhanumurthy told Financial Express Online.

Withdraw loose monetary policy of the pandemic times

Kotak’s Bhardwaj said, India needs to react and withdraw pandemic related emergency measures. The excess liquidity that is there in the system, and the overnight rates which are hovering close to the lower end of the policy corridor also needs to be adjusted and fast tracked, she added. “Point is where we stand today, we see overnight from FOMC minutes they have turned extremely aggressive, and this is the first time they are talking about rundown of their balance sheet sometime in the middle of year. That is something which is expected to be on their sentiments and to that extent it will impact Indian asset classes as well,” she added.

Emkay economist Arora said in a note that Fed action would mean EM cherry picking will happen, which will continue albeit more stringently. Hard-to-value innovation and alternative assets could be at risk, she added.

Truly decoupled? Not really

So far the impact of the omicron variant has been mild globally and even though there is pressure on the central bank to raise interest rates, RBI would not be looking at a rate hike this quarter and it would wait and watch, Arora told Financial Express Online. It may have to eventually follow suit but unless there is any major financial disruption in equity markets or currency markets, RBI may only look at a hike in the April-June quarter. RBI would not be much reactive to Fed actions, she added.

At large, India will have to have an independent policy based on its own domestic needs. “We have to have our own independent monetary policy. Given the domestic conditions and given foreign economic conditions. Unlike other countries, in India post COVID-19, it is the monetary policy which became the first line of defence. The reversal of that monetary policy will also have to be on the basis of our own conditions,” Bhanumurthy said.

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