RBI expected to front-load more hikes in coming policies
Premium- In 2020, RBI front-loaded the covid-induced easing with two consecutive repo rate cuts
The Reserve Bank of India (RBI)’s decision to hike the repo rate by another 50 basis points to 4.9% is only a tad higher than our expectation of a 40 bps hike. The Monetary Policy Committee (MPC)’s message of focusing on withdrawal of accommodation, to move away from the “accommodative" stance, despite hike in the reverse repo rate in April and the off-cycle repo rate hike in May, was expected. As inflation nears 8%, at a nearly eight-year high, RBI’s focus to bring inflation back to within the upper tolerance band of 6% clearly indicates the possibility of more rate hikes in the near term.
In 2020, RBI front-loaded the covid-induced easing with two consecutive huge repo rate cuts of 75bps and 40bpsin March and May, respectively, before holding it steady for the next two years. Interestingly, the current cycle of rate hikes also starts with large and front-loaded moves, much in contrast to RBI’s “baby step" hikes during 2010 and 2011. Even if the current approach means a somewhat slower recovery immediately, the central bank stays focused on long-term financial stability and sustainability of growth.
Overall, the challenges to the growth-inflation dynamics are unmistakable with volatility in global markets following geopolitical spill-overs, and rising inflation due to disrupted supply chains, war-related sanctions, output losses and trade restrictions, leading to a rise in commodity prices, posing both direct and indirect risks. While talks on procurement of discounted Russian oil post-sanctions and the India Meteorological Department’s forecast of a normal monsoon with decent spatial distribution offer silver-linings, RBI’s unchanged FY23 gross domestic product forecast of 7.2%, is not free from downside risks. The surge in consumer price inflation to a 95-month high of 7.8% in April reflects a clear broad-basing of inflationary pressures. Despite the excise duty cuts on fuel and ban on wheat exports by the government, RBI expects CPI inflation to average 6.7% in FY23, significantly higher than its April projection of 5.7%.
The higher-than budgeted government borrowing programme with a surprise sharp off-cycle policy tightening had triggered a spike in India’s bond yields in recent weeks. Yield of the 10-year benchmark government paper above the psychological mark of 7.50% reflects pricing in of continued aggressive rate hikes. After providing for necessary adjustments related to overall consolidated supply (projected at ₹28 trillion including GSec, SDL and corporate bonds vis-à-vis pre-pandemic supply of about ₹20 trillion), spread between 10-year and effective overnight operative rate stands at over 180 bps, even after today’s rate hike (as against a pre-pandemic spread of about 135 bps with the repo at 5.15% and 10-year Gsec at 6.50%).
However, while withdrawal of the monetary accommodation will continue, and it is difficult to expect easing of yields, instances of 25-30bps occasional softening in the 10-year yields from the current level of around 7.5% cannot be ruled out in the next 1-2 months. While the policy bias for caution is justifiably strong at present, one feels that policymakers need to consider certain low-ticket yet meaningful support for the economy, especially for small and medium businesses and weaker segments.
For instance, schemes such as ECLGS and CGTMSE, which are directed at MSMEs, have contributed significantly to help them sail through covid-19 waves. Along similar lines, RBI’s decision to revise the limits for individual housing loans and the entry of rural cooperatives in the housing space are welcome steps that will likely provide a level playing field to all competitors and offer rural borrowers wider choice. Further, the increase in limits on e-mandate on cards for recurring payments and RuPay credit cards getting linked to Unified Payments Interface(UPI) should encourage small entrepreneurs to go digital.
To sum up, considering the current inflation dynamics in India and globally, one feels that RBI will continue with front-loading more hikes potentially in August and October MPC meets, before likely shifting to a low gear for bulk of the second half of FY23, unless a fresh set of concerns emerge on the inflation front.
The central bank is likely to take into account the significantly stronger influence of external benchmark linked rates (EBLR) today, than say, five years ago, which should mean meaningfully faster transmission of RBI hikes in the current cycle than before.
The author is chief economist and head of research at Bandhan Bank. Views are personal.