BackRate hike quantum to slow
The most likely outcome of the December MPC review appears to be a 35 bps rate hike.
PremiumThe upcoming meeting of the Monetary Policy Committee (MPC) in December will occur amid a moderation in domestic retail inflation and a headline GDP growth print for Q2FY23 that was in line with expectations. Buttressed by the divergence in views of some of the MPC members expressed in the minutes of the September policy meeting, we expect the size of the repo rate hike to be restricted to 35 basis points (bps) in the next review, lower than the 50 bps each seen in the last three meetings.
To recap, the CPI inflation print for October, released since the last policy meeting in end-September, had moderated appreciably to 6.8% while remaining stubbornly above the 6% mark. We expect a further base effect-led softening in November to be released shortly after the MPC’s December meeting.
One of the emerging sources of relief regarding the inflation outlook has been the brisk rabi sowing, especially for crucial crops such as wheat, rice, and mustard.
Moreover, healthy reservoir levels and improved availability of fertilizers are encouraging. Additionally, crude oil prices have softened considerably over the last month. With a retreat in the Dollar Index, the INR has reversed some of its weakness against the dollar, staving off a portion of the pain related to the landed price of imports. However, there is anecdotal evidence of rising rentals, and we remain watchful that the robust domestic demand for services may augment the momentum of inflation in this category going ahead.
On balance, we expect the CPI inflation to print at 6+/-0.3% in the remainder of this fiscal and do not see a case for a revision in the MPC’s CPI inflation forecast of 6.7% for FY2023. However, with a subsequent downshift anticipated in the inflation prints in Q1 FY24, it may be appropriate to emphasize the average inflation expected over the next 6-12 months, even if a few more prints linger above the MPC’s 6% upper threshold.
On the growth front, the 6.3% YoY expansion in India’s GDP was in line with the MPC’s prescient forecast. A normalizing base caused the YoY growth to slide from 13.5% in Q1 FY23, a comparison that we feel is best ignored. More importantly, relative to the respective pre-covid quarters of FY2020, the pace of GDP growth doubled to 7.6% in Q2 FY2023 from 3.8% in Q1 FY23, revealing a pick-up in the underlying momentum of domestic economic activity.
To meet the MPC’s FY23 growth projection of 7%, GDP needs to clock a modest 4.6% YoY rise in H2 FY23. How plausible is this when domestic monetary policy has tightened appreciably, although its impact would arguably be felt with a lag?
In recent months, the looming impact of a global slowdown on India’s exports has been the chief source of consternation regarding the growth prospects. For instance, merchandise and services exports declined in October relative to the previous month. However, so did such imports, and we believe these trends reflect the holidays in the month during the festive period and are not entirely attributable to global demand concerns.
We also aver that there have been some pleasantly positive developments on the growth front, including the aforementioned pick-up in rabi sowing and a robust consumer sentiment during the festive period.
Eliminating the treacherous base effects related to the shift in the festive calendar, the average growth for October-November 2022 for the available high-frequency indicators is broadly similar to the pace seen in Q2 FY23. Therefore, we don’t see an urgent case for the MPC to pare its 7.0% FY23 GDP growth forecast.
If, however, the MPC chooses to lower its GDP projections for H2 FY23 on an anticipated softness in exports, this should be accompanied by a relatively dovish tone regarding the timing and pace of future rate hikes, in our view.
Besides, global central banks are increasingly likely to pare the size of rate hikes amidst slowdown fears after the aggressive frontloading seen so far, which may provide some comfort to the RBI. The chairman of the US Federal Reserve Bank recently highlighted that smaller rate hikes are likely going ahead while cautioning that monetary policy will likely stay restrictive until there are signs of progress on inflation.
So, to conclude, the most likely outcome of the December MPC review appears to be a 35 bps rate hike, with an increased emphasis on data dependency characterizing the monetary policy outlook.
The author is chief economist at Icra Ltd.
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