Policy perils in a data-driven world
3 min read . Updated: 09 Mar 2023, 11:02 PM IST
PremiumIndia’s Economic Policy Uncertainty Index surged in February. This was mainly due to tighter liquidity conditions in the country, after a spate of interest rate hikes by the Reserve Bank of India.
In an era of data-dependent global central banks, change is the only constant. The US Federal Reserve (Fed) chairman Jerome Powell’s latest comments on potentially higher and faster interest rate hikes has left global equity investors tizzy. Powell’s testimony to the Congress this week was more hawkish than his earlier commentary in February. Since the battle against inflation doesn’t seem to be over yet, the market is now fretting about more rate hikes.
“In December the median projection from Fed officials was for the Fed funds target rate to be at 5.1%, but Powell’s higher for longer message on rates now means markets are pricing the Fed funds rate at 5.4% for year-end. This is getting on for 100 basis points of hikes from here," James Knightley, chief international economist, at ING said in a 7 March note. One basis point is one-hundredth of a percentage point. “We have an intensifying issue regarding both the cost and access to borrowing, which runs the risk of a harder landing for the (US) economy than markets are currently discounting," he added.
Hence, the US inflation and employment data ahead of the Fed’s next monetary policy meet, scheduled later this month, are crucial. Even so, a more-than-expected hawkish stance by the Fed doesn’t bode well for the overall global monetary policy scenario.
As the alongside chart shows, India’s Economic Policy Uncertainty Index has surged in February. This was mainly due to tighter liquidity conditions in the country, after a spate of interest rate hikes by the Reserve Bank of India (RBI). The index computed by economists Scott R. Baker, Nicholas Bloom and Steven J. Davis is based on the frequency of articles in domestic newspapers mentioning economic policy uncertainty.
“In the near-term, economic policy uncertainty is likely to linger," said Madan Sabnavis, chief economist at Bank of Baroda. He feels that Powell’s latest indication of aggressive rate hikes and higher than anticipated terminal rate could also put some pressure on the RBI to raise rates. Remember, RBI’s February Monetary Policy Committee (MPC) minutes showed divergence among members with 4:2 vote split.
The next RBI meeting is scheduled in April. Apart from February and March retail inflation data, any developments related to El Niño risk, which has a bearing on India’s monsoon trajectory, would also be important. If the El Niño risk materializes, it could delay a recovery in rural demand. Additionally, any further increase in oil prices would add to inflationary pressures.
“We continue to expect RBI to hike policy by 25 basis points in April, but now expect the stance to be retained as withdrawal of accommodation," said Gauraa Sen Gupta, an economist at IDFC First Bank. The stance will give RBI policy flexibility to respond to the uncertain global monetary policy environment, she added.
Meanwhile, so far this calendar year, the Indian equity market has been a laggard, with the MSCI India Index falling 5.2%, trailing some Asian counterparts such as China, which have risen during this period. It has also underperformed MSCI Asia ex-Japan and MSCI World indices. For India, among the dampeners were a rout in Adani Group stocks. Also, the December quarter corporate earnings performance was largely a mixed bag. Amid this, an increased tightening of monetary policy conditions would not do any good to the already muted investor sentiment. While valuations have moderated from the peaks, they are still pricey. At one-year forward price-to-earnings multiple, MSCI India is trading at 17.2 times, higher than MSCI Asia ex-Japan and MSCI Emerging Markets indices.