Home / Opinion / Columns /  End of front-loaded hikes?

The Monetary Policy Committee’s (MPC) upcoming review is likely to be at the cusp of a shift from front-loaded rate hikes, initiated at its off-cycle meeting in early May 2022.

If this does happen, it will be in line with most major central banks (G10 CBs) which are shifting to a more calibrated, data-driven pace of tightening, away from the aggressive, synchronized front-loading of rate hikes. Central banks in Australia and Canada have already moderated their pace, and others are beginning to signal moderation. The European Central Bank (ECB) is the last major holdout on the continuing steep rate path, unsurprising since it started tightening late.

In the US, the comments of members of the Federal Reserve suggest a split in thinking on the pace of tightening, but the consensus still seems to be that rates will need to be higher for longer. Markets had begun to price in a 50 basis points rate hike at Fed’s 14 December review, after an unprecedented four consecutive 75 bps hikes. That expectation seems to have dampened a bit, but not significantly, after the November non-farm payrolls data release, which showed a far stronger US labour market than analysts had forecast. Strong payroll additions, sticky low unemployment rate and very strong wage growth are likely to present a quandary for the Fed.

India, like all emerging markets, has been affected by the spillovers from the G10 CB actions. The impulses were transmitted largely through three channels: capital account flows, large moves in commodities prices, and trade transactions, both merchandise and services. The intensity of the first two channels has recently abated, but the third, via an exports slowdown, which is more a real economy phenomenon, is now an emerging as a brake on domestic growth.

In this context, here are some thoughts on the evolving inflation-growth dynamics in India.

The October CPI inflation print was just a shade above market forecasts at 6.8%, largely due to slightly higher food prices. The worry though, is that core (non-food and fuel) inflation remains sticky. By every measure— trimmed means, momentum diffusion, share of core components with inflation greater than 6%, etc.—core inflation remains high and might result in headline inflation remaining elevated despite falling food and fuel prices. Our view is that CPI inflation, given seasonal trends, will wobble near 6.6% over the next few months, falling below 6% only in March 2023. Thereafter, CPI inflation is likely to fall to an average of near 5% in FY24, given reasonable economic assumptions. Globally, developed markets’ inflation is expected to drop from currently high levels, given normalizing global supply chains, falling freight and shipping rates, moderating demand, etc.

Domestic economic activity, however, remains surprisingly resilient, at least in specific segments of demand, despite the rapid transmission of the repo rate increases to lending rates (due to the switch to the repo rate-linked lending rate), especially MSMEs and home loans. Credit demand, even for term loans, remains strong, especially among small and medium businesses. The November Manufacturing PMI suggests continuing momentum.

However, the worry now is whether there might be a tipping point with rising borrowing costs and squeezed cash flows, where an exogenous shock triggers a non-linear, material impact on financial sector stability. There are some early signs of deceleration in activity, which were seen in the Q2 FY23 GDP data prints. Despite the robust 6.3% y-o-y topline growth, the underlying measure of economic activity, the Gross Value Added (GVA) grew only 5.6%. Market surveys suggest slowing demand for FMCG goods in the post-festival months. Inevitably, as the world economy slows, India’s merchandise exports growth will also moderate, as the October contraction suggests.

Given this concern, the MPC, having made “substantial progress" and approaching the presumed terminal policy rate for this cycle, will probably consider slowing the pace of tightening, take stock, monitor, and keep options open to respond to incoming economic and financial data. We expect a further hike in the repo rate by 25-35 basis points from the present 4.9%, the quantum depending, inter alia, on how anchored inflation expectations remain, while retaining the stance of accommodation removal, given the conditions defined earlier.

The author is executive vice-president and chief economist at Axis Bank. Views are personal.

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