By Anubhuti Sahay
Yet another rate hike is widely expected at the upcoming Monetary Policy Committee (MPC) meeting on December 7. However, the size of the increase is likely to be smaller than the three previous 50-bps hikes since June. We expect a 35-bps increase in the repo rate, taking it to 6.25%, next week, primarily driven by three factors: (i) softening domestic inflation, (ii) the need to assess the impact of rate increases so far on the pace of economic activity amid rising recession risks in major economies in 2023, and (iii) slower pace of rate increases globally.
We expect India’s November CPI print at c.6.5%, down from 6.77% in the previous month, on the back of lower prices of perishables, softer global commodity prices, and favourable base effects. Assuming no adverse price-shocks, headline CPI is likely to dip below 6%—the upper threshold of the mandated CPI band of 2-6%—by March/April 2023.
We also expect CPI to average 5% in FY24 (year beginning April 2023). Given the increased likelihood of moderating inflation over the next 12 months, we expect the MPC to first slow the pace of rate increases and then pause on rates after the February policy meeting.
Such an approach is also justified given that domestic activity is likely to moderate over next one year, amid increasing recession risks in major economies. The year 2022 has been a year of policy rate increases in India, as well as globally; the MPC has so far raised rates by 190 bps since May. The coming year will be the year when the impact of these rate increases on economic activity becomes evident; monetary policy transmission to the broader economy usually happens with a lag of 6-9 months.
Like any other central bank, the Reserve Bank of India (RBI)/MPC will seek to avoid the risk of over-tightening, thus slowing the pace of rate increases as it awaits more data. This seems prudent.
A likely moderation in the pace of rate increases globally should provide the MPC with the space to taper the size of its hikes. For instance, the US Federal Reserve has highlighted that it is likely to slow the pace of rate increase from 75 bps towards 50 bps at the next meeting.
With reduced pressure on the currency and reduced peak rates expectations for the Fed fund-target rate, the RBI MPC is likely to use the breathing space to assess the impact of its monetary policy action to date on the broader economy.
Notwithstanding the above, we do not expect the MPC to lower its guard as risks of upside inflation surprises (e.g., firmer China reopening and higher commodity prices) cannot be ruled out in 2023.
The past three years are littered with examples of unexpected adverse inflation shocks. Thus, even as the MPC is likely to draw comfort from recent inflation trends (crude oil prices are trading below $90/bbl currently, the first time since the start of 2022), we expect it to remain vigilant on any upside surprises over the next few quarters.
We thus expect the MPC to maintain the guidance of ‘withdrawal of accommodation’ and remain data-dependent. We think a shift to a ‘neutral’ stance next week would send conflicting signals, as RBI has previously defined a ‘neutral’ stance as flexibility to cut, pause or hike.
We do not think the economy is close to a point where the MPC would indicate any inclination towards cutting or pausing. Any change in stance to ‘neutral’ is therefore still a couple of meetings away, in our view. We expect it to be delivered in February 2023 when the repo rate is closer to the terminal repo rate.
While we do not expect any change in its inflation and growth forecasts for FY23, it will be interesting to see the MPC’s projection for headline CPI inflation and growth for the quarter ending September 2023.
At the September 2022 policy meeting, the MPC provided an inflation forecast for June 2023 quarter at 5%. Any CPI inflation projection lower than 5% for the September quarter could impact market expectations around the timing of rate cuts in India too. Currently, the market is pricing in one rate cut of 25bps in 2024.
Yet another interesting focus-point for the markets when it comes to next week’s MPC meeting would be on the voting pattern around the rate decision. To recall, the September decision of 50-bps increase was not a unanimous decision as MPC member Ashima Goyal voted for a smaller rate increase, of 35 bps.
More importantly, the minutes of the September policy meeting showed that member Jayanth Varma wants the MPC to pause now, as the repo rate is closer to 6% and inflation risks are abating. While we see limited risks to our call of 35-bps increase next week, yet another divided MPC decision is highly likely.
Markets would watch out in case two members vote for a pause in repo rate along with the commentary of the other four members to assess the possibility of a sooner-than-expected pause in rate action. Markets will also watch out for any comments from RBI on the reduced size of liquidity surplus in the banking system.
Assurance from RBI that adequate liquidity will be provided to remain supportive of growth is likely to soothe market concerns about liquidity switching to a deficit mode next year.
Overall, while not much surprise is expected from the MPC in terms of action, its commentary, the voting pattern, and its projection for quarter ending September 2023 will be scrutinised closely to pick cues for future policy decisions.
The writer is Head, South Asia, Economics Research, Standard Chartered Bank