Friday’s hawkish 50-basis-points increase in the repo rate—the third in a row—suggests the Monetary Policy Committee (MPC) remains concerned about inflationary pressures persisting even after the headline print peaks. That’s a fair assessment because although prices of a host of commodities, including crude oil, are softening, the absolute price line could remain elevated. Retail inflation is tipped to rule above 6% for three-fourths of the current fiscal year, sliding below that level only in the fourth quarter of FY23, and to 5% thereafter in the first quarter of FY23. Critically, Reserve Bank of India (RBI) Governor Shaktikanta Das mentioned that, currently, much of the price pressure now is driven by supply-side constraints. However, as the economy gathers momentum, demand will also play its part in driving up prices.
Indeed, RBI sounds a lot less anxious about the economy now. Governor Das cited several high-frequency data points to say the economy seems resilient, also pointing out capacity utilisation in Q4FY23 was 75%-plus. In fact, the central bank shrugged aside concerns on muted rural demand and the “mixed signals” from the hinterland, expressing hope that a good kharif crop would boost farm incomes. To be fair, the governor did mention the uneven rains but, again, seemed to downplay the concerns by citing good buffer stocks. While there is no doubt the economy is showing a lot more spunk and that consumer demand is on the rise, there are some headwinds. Key among them is rising interest rates. For all the talk of credit growth having hit 14%, it should be remembered that it comes off a very weak base. In a highly inflationary environment, the real growth would be far more muted. Secondly, as interest rates rise, borrowers are drifting to banks where credit is cheaper than in the bond markets. Also, loan growth has been driven almost entirely by the increase in retail loans. Against this background, when rate hikes are meant to curb demand, leaving the gross domestic product (GDP) growth forecast for FY23 unchanged at 7.2% is somewhat curious.
To be sure, RBI is well within its rights to believe that front-loading of rate hikes is necessary to prevent price pressures and inflationary expectations from getting embedded. After all, core inflation is still high, at around 6%, and that will take time to ease. Thus, the calibrated withdrawal of accommodation will ensure that the second-order effects are reined in and the price rise is tamed. But, it is unlikely all this will not upset the growth momentum, given that global growth and trade are also moderating and could hurt the already-weakening exports. There are those who believe some part of the hike of 50 bps has to do with the defence of the currency. That seems unlikely. While the Governor countered the suggestion saying rate changes are primarily decided by the local inflation-growth dynamics, he did point out that a weaker currency does result in imported inflation. In a rare reference to the external sector, he asserted the current account deficit (CAD) would be ‘manageable’ citing strong FDI inflows and a reversal of FPI flows. Nevertheless, the rate hike cycle shouldn’t last too long; right now, a 6% peak rate by the end of 2022 seems possible. By then, the US Fed would have tightened policy further, giving us a better sense of where global growth and the local economy are headed.