BackMPC to maintain status quo until Q1 FY25 at least
With inflation drifting lower in 2023 from their record levels in 2022, most hawkish central banks are likely to turn neutral in the coming months
PremiumIt is never an easy moment for central bankers. In last three years, they have swung from being overtly accommodative to the current restrictive phase. With economic activity and inflation still adjusting to pandemic-induced behavioural changes and policy responses, conventional economic markers have been subjected to a lower signal-to-noise ratio amid elevated geopolitical uncertainty worsening the overall backdrop.
In recent months, this has divided the central banks into three camps.
The first camp, which is in a minority at this moment, has begun its rate-easing cycle. This includes countries like Brazil, Chile, China, Peru and Poland—and while their count is less, they have a sizeable 21.2% share of the world GDP.
The second camp has 15 countries including India, which have maintained a status quo on monetary policy in the last four months. These countries account for 15.2% of the world GDP. These are the ‘wait-and-watch’ players.
The last camp, where the majority lies, has 16 countries (excluding Russia and Turkey) that have hiked their monetary policy rate at least once in last four months. These countries together account for 51.5% of the world GDP.
Clearly, the synchronized monetary policy cycle seen at the beginning of the pandemic now seems to be disintegrating, with central banks responding to idiosyncratic and domestic challenges in every country. However, there is a clear divide between developed market (DM) and emerging market (EM) central banks. While DM central banks dominate the third camp of hawkish players, the EM central banks have started to turn dovish (first camp) or have preferred to stay neutral (second camp).
With inflation drifting lower in 2023 from their record levels in 2022, most hawkish central banks are likely to turn neutral in the coming months. What is uncertain is whether the dovish camp of central banks would see higher participation in next 3-6 months.
The recent run-up in commodity prices (esp. crude oil) and US yields poses a systemic risk for growth, inflation and financial stability for the rest of the world. This would require careful assessment of spillover impacts and judicious use of policy room to address the emerging macro-financial challenges.
In the case of India, although there is an expectation of moderation in growth momentum in FY24 in line with rest of the world, the country is likely to outperform all its key peers. This allows policymakers to focus on getting inflation under control.
The broad picture on India’s inflation is one of uneasy comfort. It’s comforting because (i) headline inflation is projected to get back to the target band at 5.5% in FY24 (QuantEco estimates) from 6.7% in FY23, and (ii) core inflation has now moderated to its long-term trend of ~5% (with the likelihood of some undershooting in the near term). At the same time, there is unease stemming from various quarters—the shock from food inflation was significant in July-August FY24.
An underwhelming monsoon outturn with respect to highly uneven intertemporal and geographical distribution along with lingering El Nino risks are feeding concerns on agri prices remaining elevated, especially for the staples. While administrative measures can cushion the severity, recent evidence prompts us to remain vigilant on the food price trajectory.
Second, the recent sharp rise in India’s crude basket does not bode well, adding one more dimension to inflation risks. The actual impact on retail inflation might remain muted this time as a large part of price increase could possibly be absorbed by the government (cut in duties) and OMCs (reduction in margins), especially as the country enters an election season. While we remain vigilant, we expect risks to be in balance. For now, CPI for September 2023 is most likely to provide further reprieve as it is projected to decelerate sharply towards 5.0-5.5% range from 6.8% in August 2023.
The RBI has remained in a pause mode after its last rate hike in Feb-23 with unchanged stance of “withdrawal of accommodation". It is imperative to maintain the neutral policy rate (real repo rate adjusted for expected inflation) in the 1-2% range depending upon the strength of the underlying recovery and the deviation from the inflation target. While CPI inflation is expected to moderate further in FY26 towards 4.5-5.0% range, the band of uncertainty is wide for these projections at this moment. With visibility being limited, it would be appropriate to be nimble and non-committal and keep extreme hawkishness or bearishness at bay.
We continue to expect the MPC to maintain status quo (this could turn out to be the longest phase of no-rate action) at least until Q1 FY25 to anchor inflation expectations and guide actual inflation towards the 4% target. To ward off instability concerns, especially from global financial markets, it is prudent to maintain a somewhat hawkish overture at the moment without causing any significant collateral damage. This can be achieved by maintaining core liquidity in the non-inflationary territory (i.e., a surplus of less than 1.5% of NDTL) to keep short-term rates in the current Repo-MSF bracket of 6.50-6.75%.
The post-pandemic phase will be rife with bouncers (inflation conundrum) and yorkers (global financial market volatility). It is important to keep wickets and play with a straight bat to anchor the innings.
Shubhada Rao is the founder of economic research firm QuantEco Research. The views expressed are personal.
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