It might look somewhat odd that the Reserve Bank of India (RBI) took a more hawkish stand than in the September policy, despite pruning growth projections for FY23 by 20 basis points. But the reasoning is that while the economy may not be roaring, it is also not on the verge of a collapse. On the other hand, the chances of inflation spiking once again can’t be ruled out; in particular, any international disturbances—geopolitics and the weather—would exacerbate the vulnerability of food inflation. While Governor Shaktikanta Das asserted on Wednesday that the worst of inflation is over, he also expressed concern on a stubborn core inflation, which could average 5% next year. What must have weighed on the MPC’s mind is the possibility of imported inflation continuing to stay elevated.
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This explains the MPC’s unchanged stance of staying in “withdrawal of accommodation” mode while leaving the inflation forecast for this year at 6.7%. Again, while Das reassured the bond markets on liquidity, he told them in no uncertain terms that they should wean themselves off the surplus liquidity overhang and not take it for granted. It is possible that liquidity will be ample with government expenditure picking up, the currency in circulation moderating post the festive season and more forex inflows. But the signal to the bond markets is unambiguous. Clearly, the central bank is unwilling to let second-order inflation effects to gain momentum and is willing to do what it takes to break the back of core inflation. And, although the economy is expected to slow very sharply in FY24, it believes it has the room for more rate action. Moreover, the central bank wants stability in the currency and is providing some support for the rupee. So, while the days of 50-bps hikes may be over, going by the tenor of Wednesday’s pronouncements, the days of tightening are not. RBI has observed that the policy rate, adjusted for inflation, is still accommodative and, therefore, one should expect a 25 bps hike in the repo in February, which would take it to 6.5% from 6.25%. That might not be the end, though much would depend on the global situation, especially the rate actions and commentary of the US Fed.
Overall, RBI’s actions may be justified in the current context but will definitely hurt borrowers and demand for credit, given the speedy transmission of rate hikes into interest rates on loans. The yield on the benchmark may have settled just 2 bps higher at 7.271 at close on Wednesday after a bigger move immediately after the monetary policy announcement, but RBI’s clear signalling to the markets on its determination to battle inflation would not be missed, and yields could move up to 7.4% in the near term. Post that, the borrowing calendar for FY24 would be an added factor determining the direction of yields. The spread for corporate bonds—over the treasury—are tipped to go up gradually and the cost of capital for companies too would move north. Costlier money will hurt the economy, which is tipped to grow at only sub-6% next year, or even slower. That may be faster than many other countries, but is of little consolation to the millions of unemployed. In its fight against inflation, RBI must weigh the perils of pushing the economy down the slope.