Given the intense inflationary pressures at home and the aggressive rate hikes and hawkish commentary from the US Fed, the Monetary Policy Committee’s 50-basis-points repo rate hike was a foregone conclusion. As of now, it appears rates are likely to go up by another 40-50 bps, though much would depend on the trajectory of crude oil prices, the actions of the Fed, and the value of the currency. At some point, however, the Reserve Bank of India (RBI) will need to shift its focus to growth, leading many to say that the peak rate will have a short staying power, and the central bank may move to cut it as soon as it becomes confident that inflation is trending down and would hit the targeted 4% mark even before it actually does get there. It is also pertinent that RBI has left its retail inflation forecast for FY23 unchanged at 6.7% even though it highlighted upside risks to food inflation. Moreover, the smaller hike of 35 basis points voted for by MPC member Ashima Goyal and RBI’s lower growth forecast for FY23 of 7% will no doubt influence the pace of tightening going ahead. Most importantly, RBI’s GDP growth forecast of 6.4% for FY24 is at a wide variance with the projections of most economists who are looking at levels closer to 5.5-6%.
In the meanwhile, RBI has maintained its stance of “withdrawal of accommodation’. There are some who argue that given that the repo rate is now 5.9%, which is where it was in June 2019, the stance should be described as neutral as it was then. Governor Das, however, asserted that with inflation expected to be elevated at around 6% in H2FY23 and with liquidity still in surplus, overall liquidity conditions remain accommodative. Therefore, given that real rates are negative, it could not be called neutral. It is possible RBI is giving itself wiggle room because it needs to hike rates further. Announcing a neutral stance today could compel it to describe a future stance as restrictive, which might not go down well with the markets.
Governor Das has done well to reassure markets that there is enough systemic liquidity with the surplus at around Rs 5 trillion and that increased government spending would mitigate the recent tightness. Not everyone is convinced, however, that liquidity will be ample in the busy season and the central must be ready to infuse funds whether via variable repos or OMOs (Open Market Operations). While merging the 28-day and 14-day VRRR auctions should help.
If the Governor downplayed the depreciation of the rupee and its impact on the current account deficit (CAD), it could be because there are reasons to believe that even if the dollar does strengthen, that strength may start fading after a few months. To be sure, the rupee may depreciate to levels of 83 against the greenback, but if this happens in an orderly fashion, it would not be so damaging. Indeed, deputy governor Michael Patra has a forecast of a 3% CAD for the current year, and there are those who believe that, ceteris paribus, the worst of the balance of payments and CAD is behind us. Also, just as the reserves have fallen due to a revaluation, they could go up again when the Fed retraces its moves. If needed, RBI can always resort to measures like special dollar windows for oil importers and special foreign currency non-resident (FCNR) deposits.