Home / Opinion / Columns /  RBI’s shift in stance imminent

Tightening monetary policy when growth is slipping and inflation is rising always creates a dilemma for the central banks.

Global economic growth was expected to decelerate and inflation accelerate, even before the start of the Russia-Ukraine conflict. The conflict has only worsened the growth-inflation matrix and raised the spectre of tighter financial conditions. So much so, S&P Global is forecasting global growth at 3.6% in 2022, a good 60 basis points below its December forecast. And it has pared US GDP growth by 70 basis points to 3.2%.

Yet, inflationary pressures have forced the US Federal Reserve, systemically the most important central bank, to go on an aggressive rate hike path this year. Europe, too, is moving forward with its tightening cycle. Many other emerging markets have also raised interest rates over the past year.

The Asian story has been somewhat different, with many central banks, including the Reserve Bank of India (RBI), looking through inflationary pressures to pursue growth. Of late, we have seen some of them defy street expectations on dial-back of accommodative stance. But interest rates are expected to go up in most Asian economies, as it will become difficult for central banks to ignore inflationary pressures.

The economic context has dramatically changed since the last review by the Monetary Policy Committee of the RBI in February. Risks from the omicron variant, which proved to be mild, have been quickly replaced by geopolitical risks. The dovish stance was premised on retail inflation gliding to 4.5% in fiscal 2023, with the second half print at 4%. But that scenario is unlikely to play out now, given that crude and commodity prices have surged after the Russia-Ukraine conflict.

We expect the RBI to change its stance to ‘neutral’ from ‘accommodative’ on 8 April, after its monetary policy review. That will provide it with the flexibility to move in either direction later.

We also see the RBI initiating a move towards the normalization of the policy-rate corridor (the gap between the repo and reverse repo rate) by raising the reverse repo rate by 25 basis points. This will be inconsequential as call money rates have already firmed up and are now closer to the reverse repo rate.

This will prepare the markets for repo rate hikes, which we expect to be 50-75 basis points in fiscal 2023, beginning with the June monetary policy review. This is needed to reduce the risk of already-high inflationary expectations from getting de-anchored.

Here’s why:

In the base case, CRISIL expects the average Consumer Price Index (CPI)-based inflation to stay firm at 5.4% in fiscal 2023 if the price of crude oil averages $85-90 per barrel. The risks to inflation are firmly tilted upwards, particularly if the current geopolitical strife prolongs.

It is true that inflation is largely supply-driven as demand remains weak. Private consumption demand continues to be the slowest-growing component of GDP. But supply shocks do not seem to be transitory anymore. Rather, they are becoming persistent. What started as a gradual increase in commodity and crude prices in 2021 has only intensified now, and it will be difficult for the RBI to ignore these developments.

Pressure on core inflation, which has remained sticky in the 5.5-6.0% range, has not abated despite weak demand. It could increase as input costs continue to rise.

WPI inflation for non-food commodities, a proxy indicator of input costs, was at 15% in February.

The recent Business Inflation Expectation Survey of IIM Ahmedabad showed that one year ahead, business inflation expectations in January 2022 increased to 6.0% from 5.45% in December 2021. This is the fastest increase since 2017 when the survey was launched. Companies are passing these costs to end consumers wherever they can. Additionally, services inflation, which has so far trailed goods inflation, is expected to go up as contact-based services rebound.

In fiscal year 2021-22, relatively low food inflation, with a weight of over 40% in the consumer price index, kept a lid on overall inflation. While Skymet and the Indian Metrological Department (IMD) have predicted a fourth consecutive normal monsoon this season, prices of agriculture inputs from fertilizers to pesticides have spiked, and prices of wheat and maize have started rising.

And finally, household inflation expectations, which nudged down a bit in RBI’s January Survey, are set to firm up again.

Since supply shocks are better handled via fiscal policy, we should also expect duty cuts on commodities and, in particular, crude oil if the Russia-Ukraine conflict and its after-effects prolong.

(Dharmakirti Joshi is chief economist, Crisil Ltd. Views are personal.)

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