By Upasna Bhardwaj
Toeing on the heels of the May off-cycle policy, the Monetary Policy Committee (MPC) continued to appropriately restate the focus of the Committee on anchoring inflation expectations. The Reserve Bank of India’s (RBI) acknowledgement of inflation persisting above the 6% level through 3QFY23 necessitates frontloaded actions. Accordingly, the MPC has moved quite aggressively and swiftly over the last two months. After the shift of forward guidance to the withdrawal of accommodation and normalisation of the Liquidity Adjustment Facility (LAF) corridor (through SDF introduction at 40bps higher than the then reverse repo rate) in April and the subsequent 90 basis points (bps) Repo rate hike, the MPC has managed to play reasonable catch up in the fight against inflation. The effective cumulative rate hike by the RBI since April (as reflected in the higher overnight MIBOR rates) has been ~110bps.
The June policy narrative and forward guidance seem to be fairly consistent with the current inflation-focused stance of the RBI, providing clarity on the plausible policy actions going ahead. The way forward has been summed up well by the Governor’s concluding statement “experience teaches us that preserving price stability is the best guarantee to ensure lasting growth and prosperity.” RBI revised the average inflation upward for FY2023 by 100bps to 6.7% (Kotak: 6.5%), accounting for risks emanating from elevated commodity prices and the consequent pass through. More importantly, the 1HFY23 inflation is estimated to average 7.5% (Kotak: 7.3%), and it’s only in the 4QFY23 that inflation is expected to taper to sub-6%. The RBI, for now, seem comfortable with the underlying growth momentum and has retained the GDP forecast at 7.2% (Kotak: 7.3%). Given that monetary policy impact comes with a lag of 2-3 quarters, we expect the policy tightening to weigh on growth prospects in FY2024, especially as the economic recovery remains fairly uneven.
However, the immediate objective of the MPC, correctly so, remains to tame inflation and hence the need to continue with policy tightening. We expect repo rate hike of 35 bps in the August policy, followed by a 25bps hike in September and December policy. Given that inflation prints are expected to trend lower than 6% from December onwards, as the impact of monetary tightening begins to keep a lid on inflationary expectations, we see room for a possible pause in the February 2023 policy (FY2023 repo rate exit at 5.75%). Notably, the struggle against inflation, though painful in the near term, could be shallower and shorter than expected, with a likely terminal rate of around 6.25%.
More importantly, the MPC has removed much of the ambiguity in the stance by dropping the phrase “remain accommodative”. We believe this shift to be a step closer to a “neutral” stance, although the real policy rate remains negative and will hold back the MPC from tweaking the stance until the 2QFY23 meetings. As we progress towards withdrawal of pandemic induced measures, it is imperative to shift the overnight money market rates closer to the Repo rate as against the sub-SDF levels currently. With the systemic liquidity surplus expected to drain further in 2HFY23 (near 1% of NDTL), we expect the effective policy rate hike to be 110bps rest of the year (against our expectations of 85bps of Repo rate hike).
While the need for incremental CRR hikes may not be necessary but we do expect another 50 bps of CRR hike by end-FY2023 which could create room for an orderly completion of the government’s borrowing program. While the shorter end of the yield curve will remain a policy reaction function, the far end will need measures like operation twist/OMO purchases (intermittently in 2HFY23) to avoid disruptive up move given the supply overhang.
The author is the Chief Economist of Kotak Mahindra Bank. The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organisation or the Kotak group.