As India faces immediate inflation upside risks, the RBI would need to act fast – bringing forward policy rate hikes and hardening stance, even while the US Fed scaled back rate hike expectations due to the Russia-Ukraine war. US Federal Reserve Chairperson Jerome Powell said Wednesday he will back a 25 basis points interest rate hike in the upcoming FOMC meeting, in comparison to market-wide expectations of a 50 bps rate hike, taking into account the geopolitical conditions and rising inflation in the US.
Inflation in the US is the highest since the 1980s. Inflation around the world, including in India, is expected to remain high in the near term, which could propel central banks to hike their interest rates in coming days. Economists expect RBI to move away from its soft policy stance in the upcoming Monetary Policy Committee meeting in April, and raise interest rates going forward. Inflation in India was at 6.01%, slightly above RBI’s threshold of 6%, according to latest readings.
RBI needs to toughen policy stance, raise rates faster
ICICI Securities said it expects the RBI to hike interest rates by 50 bps in the upcoming MPC meetings between April i.e. earlier than its previous expectations since inflation is expected to remain high in coming days. “With headline inflation already slightly above its target range (and likely to remain above it in Mar-Apr ’22), we believe that the RBI will be obliged to bring forward its rate increases. We now expect 50bp of increases in the repo rate in Apr-Jul’22 – whereas we were previously expecting those hikes to have come in AugDec’22,” the brokerage said.
“Brent crude prices are uncorrelated with headline CPI inflation in India (because fuel & light have only a 6.84% weightage in the CPI), but a generalised surge in commodity prices will likely keep India’s CPI inflation above 6%,” it added.
Kotak Mahindra Bank’s chief economist Upasna Bhardwaj said inflation risks in India are heavily skewed towards upside and the central bank is pushing the can forward to back near term growth. Having said that, RBI will be cautious in tone and will take into consideration how the crisis in Russia-Ukraine plays out in coming days, and if the upside risk from the geopolitical side persists.
She said she expects more central bank monetary policy members to shift towards a neutral stance in the coming days. She sees a hike in reverse repo rate of 40 bps from June onwards and a 50 bps hike in repo rate from August to October onwards.
ICRA Limited’s Chief Economist Aditi Nayar also said she expects the RBI to be less dovish in the upcoming meeting. “We continue to expect a pause with a less dovish tone in April 2022, a stance change to neutral in June 2022, and two repo hikes of 25 bps each in the subsequent two policy reviews, followed by a pause,” she said.
Inflationary pressures in the US vs India
Even though India is not directly dependent on Russia for its oil needs, it will get indirectly impacted by rising commodity prices around the globe. The inflationary pressures from the war in Ukraine are expected to affect developed nations such as the United States more than emerging markets such as India. This is why central banks in the West such as the US Fed have to act faster than their emerging market counterparts, economists said, just like they did when the COVID-19 pandemic first hit.
“The near-term effects on the US economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain,” Jerome Powell said in his testimony to the Senate on Wednesday. “Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook,” he added.
In comparison to the US, India’s balance sheet is in much better shape. ICICI Securities said inflationary surge in the US is attributable to the unprecedented surge in liquidity provided by the central bank from 2020 for a continued period of 21-months. On the other hand, liquidity in India did not peak like the US.
“Compared to that historic norm, India had no “extraordinary monetary accommodation” during the pandemic (indeed, it had instead seen an exceptional moderation in M3 growth relative to history). So, while the US does indeed need to rollback that extraordinary monetary accommodation, India faces no such imperative,” the brokerage said.
