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Views | RBI vows to go after inflation, prepares market for more hikes

views | Dec 7, 2022 7:59 PM IST

Views | RBI vows to go after inflation, prepares market for more hikes

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The message for the market was clear—at least one more hike in February with another not being ruled out later in the year if inflation proves sticky.

The Reserve Bank of India (RBI) on Wednesday made it clear it wants to bring down inflation to below 6% and then to the target of 4 percent which it said is two years away. The message for the market was clear—at least one more hike in February with another not being ruled out later in the year if inflation proves sticky.

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The market wasn’t prepared for such plain speaking on inflation or the central bank’s determination to chase it down to target. A large part of the market was expecting the RBI to announce a 35-basis point (bp) hike and indicate it is done for now and will wait and watch hereafter. Not surprisingly, following the policy, yields in the OIS (overnight index swaps) market jumped 7-8 bps along the curve as the market prepared for an almost certain February hike.
The seventh paragraph in the statement best summarises the RBI’s hawkish position:
"Inflation has ruled at or above the upper tolerance band since January 2022 and core inflation is persisting at around 6 percent. Headline inflation is expected to remain above or close to the upper threshold in Q3 and Q4:2022-23. It is likely to moderate in H1:2023-24 but will still remain well above the target. Meanwhile, economic activity has held up well and is expected to be resilient, supported by domestic demand… On balance, the MPC (monetary policy committee) is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break the core inflation persistence and contain second-round effects, so as to strengthen medium-term growth prospects."
There are several hints here of RBI's hawkish tilt.
1. The central bank is clearly uneasy about the long period that inflation has remained above target. That could be forgiven during Covid, but the indulgence needs to end—a laudable aim!
2. The governor stressed in this para and several times in the press conference that India's growth is resilient and stable, hinting at the presence of strong aggregate demand as well as the fact that growth is sound enough to allow the RBI to chase its mandate on inflation.
3. The RBI for the first time has added the phrase "break the core inflation persistence" in lieu of the earlier phrase "restraining the broadening of price pressures". Core inflation has remained sticky at around 6 percent for over a year now and breaking its persistence could take a while. And RBI seems prepared to fight that fight.
4. The governor explained that policy is still accommodative: surplus liquidity of Rs 1.6 trillion is still sloshing around in the system, he said and added that real rates are still negative. If the policy is still accommodative, that is a hint enough that the RBI will do more.
5. When asked if the RBI would be happy with 100 bps of positive real rates, considering the central bank sees inflation at 5.4 percent in Q2FY24, the governor corrected that real rates would be only positive by 85 bps. Deputy governor Michael Patra added that even then inflation would be at a distance from the target of 4 percent. In fact, Patra admitted in no uncertain terms that "the moderation of inflation will be very grudging, very uneven. So we must shepherd inflation, first firmly into the tolerance band and then to the target."
The conclusion for the market is clear: one more hike in February looks certain, and another later in the year can’t be ruled out, especially if core inflation persists. It's also clear the RBI isn’t looking at cuts anytime soon. That it sees inflation not hitting 4 percent for two years shows that the wait for a cut is at least that long—two years.
The rupee was probably another reason the RBI raised rates. It is becoming increasingly clear that even as India's growth rebounds, Indians are consuming more imports. So one way to restrain the current account deficit is to rein in growth a bit.
The RBI of course didn’t mention the rupee or the current account deficit as a reason. The governor stuck to the domestic cause—the need to bring down inflation to the legally mandated target, a level that ensures stable growth, as he put it.
In addition, the RBI has lowered the current year's growth forecast by 20 bps and that of the first quarter of next year by 10 bps to 7.1 percent. On the other hand, it raised the inflation forecast by 10 bps in Q4. A growth forecast being tweaked lower and an inflation forecast tweaked higher can’t be positive news for the markets. True enough, the Sensex and Nifty ended the day lower. But in the long run, for the economy, this is exactly the kind of central bank we want: one that uses the good cheer of growth to repair the macros of higher-than-acceptable inflation.
It must have been a contentious debate within the MPC since neither the rate hike nor the stance got the full approval of the external MPC members. But it’s good that the RBI stuck to its guns. Three cheers for this policy!
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