Don’t lift foot off the pedal

A front-loading of rate hikes will work better to tame inflationary pressures.

Don’t lift foot off the pedal
Most economists are betting on a hike of 35 basis points hike which would take the repo to 5.25%.

While the worst of inflation may be behind India and the prints in the coming months may not cross the 7.79% seen in April, inflationary pressures will continue to persist for some time. Prices of a host of commodities have certainly eased, offsetting to some extent the impact of the depreciation of the rupee, but crude oil continues to trade at over $105 per barrel. As such, retail inflation is expected to average about 6.9% in the current year before trending down to around 5.5% next year, led primarily by lower price increases. The concern here is that supply shocks might upset the calculations. Consequently, the Monetary Policy Committee (MPC) has little option but to continue to hike the policy rate later this week. Most economists are betting on a hike of 35 basis points hike which would take the repo to 5.25%. However, there is now a distinct change in the estimated terminal rate for the repo rate.

Given how inflation has been reined in, despite the weakening of the rupee, the estimates for the terminal repo rate are now much lower at 5.5-6% compared with 6.25-6.5% pencilled in a couple of months earlier. In fact, there are those who believe the pace of hikes could also be moderated. However, given potential supply-side shocks, a front-loading of rate hikes may work better to tame inflationary pressures. It’s probably better that the MPC doesn’t take its foot off the pedal just yet and risk a sharp rise in prices. After all, if growth is to sustain and consumption is to pick up to spur private sector investments and job creation, it’s important that inflationary expectations are dampened.

The MPC must use the leeway it has got with the change in the stance of the US Federal Reserve. The Fed’s tone post the FOMC meeting in late July was a lot less hawkish, even dovish some would say, and the markets now believe the pace of rate hikes would be moderated. Indeed, the appreciation in the dollar has been arrested and that has had a salutary impact on the rupee which has recovered much of its losses to move back to levels of 79.02. To be sure, the MPC would be guided less by the movements in the currency and almost entirely by the growth-inflation dynamics in the economy. However, it must be said that the Reserve Bank of India’s calibrated depreciation of the currency seems to be working well and leaving the rupee competitive would help growth. While there are clear signs of a rebound in consumer demand, much of it in the services sector, the MPC would be mindful of the fact that the chances of a global recession are on the rise. Indeed, there are those who worry stagflation could be a bigger problem as inflation rages and growth slows in developed economies. Global growth is now estimated to trend down to 2.7% in 2022 and further to1.8% in 2023. This could hurt India’s merchandise exports weighing down growth. The RBI must also ensure there is adequate liquidity in the system at a time when interest rates are going up. To be sure, the system surplus is estimated at Rs 5.5 trillion, with government cash balances pegged at a high Rs 4 trillion. That seems more than adequate, but with demand for credit picking up and any shortage would hurt credit flows and the nascent recovery.

Get live Share Market updates and latest India News and business news on Financial Express. Download Financial Express App for latest business news.

Photos