The Monetary Policy Committee’s decision to increase the repo rate by 25 basis points, taking it to 6.5%, and to stay focused on withdrawing accommodation undoubtedly makes for a hawkish tone. While the markets may have been taken by surprise—the yield on the benchmark rose to7.34% from Tuesday’s close of 7.31%—the Reserve Bank of India’s moderated inflation forecast for FY24 suggests it might soon end the war on inflation by hitting the pause button. It is probably using the time till April before breaking the news to the bond markets. RBI can’t be faulted for not having paused just yet. There is still too much uncertainty across the world as China ‘re-opens’ and economies in the West rebound. We are unclear on the level to which the US Fed is going to hike rates. At home, the lower CPI headline prints for November and December have been driven by cheaper vegetables.
Governor Shaktikanta Das is rightly concerned about the stickiness of core inflation even though headline CPI inflation is projected to moderate to 5.3% next year. As he observed, the pass-through of input costs by companies, especially in services, could keep core inflation at elevated levels. Nonetheless, the need to wait for “a decisive moderation in inflation” should not result in the economy losing momentum. Assuming there are no further disruptions in the nature of the Ukraine-Russia hostilities or the pandemic, RBI must stop hiking rates from now on. Inflation may not hit the ideal level of 4% in FY24, but it is tipped to decelerate sharply as global commodity prices soften and local supply-side constraints ease. As economists point out, there have been some structural changes in the economy, and it might take a while for inflation to fall below 5% on a sustained basis. As long as the rise in prices continues to moderate, there can be no case for any further tightening of policy. The pause should be accompanied by a change in the stance to neutral. The system liquidity is already down sharply from `7-8 trillion in April last year to around `1.6 trillion currently. Moreover, the central bank acknowledges that approximately `75,000 crore of LTROs and TLTROs will mature this year. But the bond markets need not worry on this score since the central bank will use all available options to ensure there is adequate liquidity. One should expect longer duration repo operations or even OMOs.
The central bank must now evaluate the impact of the steep 250 bps hike, both on aggregate demand and inflation. We must remember that in previous rate hike cycles, a far smaller portion of the loan books of banks was benchmarked to policy rates. Today, the bulk of the book credit is re-priced immediately; so, transmission to individuals and companies is fast. At a time when the economy is poised to slow sharply next year the, impact of costlier money could be deleterious. In this context, RBI’s GDP growth forecast of 6.4% for FY24, especially the projection of a 7.8% growth in Q1FY24, is hugely optimistic. Most economists are penciling in a growth of sub-6%. The point is the rural economy remains weak, while demand in urban India has been slowing post the festive season with the job market not showing much improvement. Costlier money for long can be bad news for the economy.
