The RBI's Monetary Policy Committee (MPC) decided to keep the repo rate unchanged in its first bi-monthly policy meeting of FY23, Governor Shaktikanta Das said on Friday. This is the 11th time in a row that the central bank has maintained a status quo on the key policy rate. In her edit piece, Latha Venkatesh jots down the main signs of hawkishness, the focus on inflation and what it could mean going ahead.
The RBI Policy on Friday was refreshingly hawkish. In one stroke the Monetary Policy Committee (MPC) and the central bank blunted all criticism of being behind the curve. They bluntly acknowledged the high inflation and clearly signalled they will change their stance and hike rates soon if incoming data warrants.
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Signs of hawkishness aplenty
First, of course, the lowest rate in the system has been raised from 3.35 percent to 3.75 percent. This merits some explaining: The fixed-rate reverse repo, the rate at which RBI used to take money from banks, for one day, by offering Gsecs as collateral has been left unchanged but is not going to be used by RBI for now. Instead, banks may deposit their excess cash for a day at the RBI’s newly created Standing Deposit Facility without getting collateral at 3.75 percent. So, effectively the lowest rate in the system has been raised by a very sharp 40 basis points, something the market didn’t anticipate at all.
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The second signal of hawkishness is the change in stance from accommodative to much less accommodative. The RBI has chosen to do this by saying it “remain(s) accommodative while focussing on withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.” This new stance shows its hawkishness first by warning that accommodation is on its way out and secondly by placing inflation ahead of growth in the sentence. Until February growth preceded inflation in the MPC's stance
The third key signal .is RBI raising its inflation forecast sharply from 4.5 percent in February to 5.7 percent. Some may say this isn’t enough and that most economists on the street are forecasting inflation at 6 percent or higher. The RBI has provided a key that it has an upward bias to its estimate.
Inflation in focus
The big surprise in the inflation forecast is the quarterly break up. RBI’s Q1 forecast is 6.3 percent, and Q2 is 5.8 percent. On the street the forecasts were exactly the opposite. The street saw Q1 inflation at 5.8 percent and Q2 at 6.3 percent. The street was sanguine that inflation in the Apr-Jun quarter will remain under 6 percent because of the high base. Clearly, the RBI sees a very sharp month-on-month increase in CPI in March and April, so much so that even last year’s favourable high base is negated.
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The RBI’s inflation forecast for Q3 and Q4 fall steeply to 5.4 percent and 5.1 percent. The central bank clearly wants to be data-dependent. Currently, it is assumed that a combination of high crude prices, Fed tightening and Covid related slowdown in China will pull down global demand and hence commodity prices from June. But if there is no evidence of that by June, chances are the central banks will move to a neutral stance in July and hike repo rates in August.
Indeed if commodity prices don’t cool by July, chances are that in the August policy, RBI will have to up the Q2 CPI forecast from 5.8 percent to 6 percent, in which case the MPC will be breaching its mandate of keeping CPI under 6 percent for 3 quarters in a row. Such a situation compels the RBI to take immediate action to bring down CPI even if it means sacrificing growth and thus a rate hike in August will be imminent. That’s why the next few inflation prints - from March to August - are extremely crucial.
A word about growth
RBI has brought down the growth forecast to 7.2 percent from 7.8 percent, citing rising commodity prices, the impact of tightening by large central banks and the continued Covid related lockdowns and supply shortages.
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However, the RBI's own repo rate hike is unlikely to hit Indian growth. Even at 4.25 percent or even at 5 percent (ie post 4 repo rate hikes), the real rate is still negative in India and favours borrowers. ( real rate is negative when the inflation rate is higher than the policy rate)
Separately, RBI has said it will bring down the surplus liquidity over a multi-year period starting this year.
Further deputy governor Michael Patra clarified at the press conference that real rates for a country in India’s stage of development need to be positive. Taking both these statements together, it looks likely the RBI hikes the repo rate to at least 5 percent in FY23.
Real rates may still be negative even after 4 hikes and hence the interest rate regime would still be supportive of growth unless there is a precipitous fall in global growth and inflation by early 2023.
One last word
Governor Das’s elegant use of language in the stance is reminiscent of a similar change signalled by governor YV Reddy. From November of 2003, Reddy transitioned from accommodative to neutral by changing the language of the stance from “ample” liquidity to “adequate” liquidity. Governor Das has done a similar transition in the April 8 policy. Reddy, thereafter went from adequate to “appropriate” liquidity as he raised rates and took interbank liquidity to the deficit. It will be interesting to see what language Das uses, as and when he transits to deficit liquidity and a tight stance.
First Published: Apr 10, 2022 4:29 PM IST