Home / Opinion / Columns /  Shifting to a lower gear

Against a tricky global economic and geopolitical backdrop, the monetary policy committee (MPC) in India surprised with larger-than-expected front-loaded rate hikes during the summer. While the cumulative repo rate hike of 190 basis points (bps) just between May and September was unusually fast, the MPC may not have finished rate hikes in the current cycle. However, as the minutes of the previous MPC meeting reveal, while the committee delivered a 50 bps hike in the repo rate in that round, there was a debate internally whether to opt for a smaller quantum of hike in September itself.

Against that backdrop, a 25 bps hike in the repo rate—taking it to 6.15%—in the current meeting is our baseline scenario. Since the September MPC, several key global commodity prices have shown signs of better stability with moderation of supply bottlenecks at the margin and no further escalation in geopolitical tensions. Globally, labour market indicators remain a mixed bag and recession concerns may prompt the US Fed to shift to a smaller quantum of rate hike in December from the large 75bps clip size in recent months. Back home, while CPI prints remain above the central bank’s comfort zone, the 5% handle now remains in sight reflecting global price trends and the nascent softening in food inflation in recent weeks.

The discussion on the terminal repo rate and the possibility of a pause in rate hikes soon may get greater prominence in and around the December MPC meeting. While the terminal repo rate will depend materially on global macro conditions and central bank actions (eg., by the US Fed) in the coming months, one does not expect it to cross the 6.5% mark in the current hiking cycle. That might mean a real repo rate of over 1% and a nominal spread of about 1.5% between Indian and US policy rates by Q1 of 2023-24.

In this context, one would like to take note of a few important points. First, for the part of assets books of the banking system that reflects external benchmark linked rates (EBLR)—which is nearly 50% now as against sub-5% in the previous hiking cycles—the pass-through is nearly instantaneous and complete. This is a key development and will likely have a meaningful bearing on the central bank’s rate action in the current hiking cycle.

Second, given that monetary policy takes effect with a lag, one feels that expectations of CPI inflation during mid-2023 is of critical importance, which is expected to soften to a 5% handle, barring further unforeseen shocks. Likely softer growth in the global economy in the coming months, no fresh surge in global commodity prices and geopolitical uncertainties, a favourable weather condition back home in India are some of key assumptions behind such forecasts.

Thirdly, while it is important for an emerging economy central bank to stay broadly in sync with the global interest rate cycle, one needs to recognize that the deviation in case of inflation and GDP growth from their respective trend-lines in the western hemisphere is much more pronounced than in India at the moment.

Apart from the much-discussed rate action, any communication from the central bank on the liquidity front might be of interest. The widening of the differential between growth rates of credit and deposit has been stark over the past six months. Credit demand improved along with the much-anticipated recovery in the economy, while deposit growth remains markedly sombre partly reflecting the sharp reduction in excess systemic liquidity by the RBI during the current financial year. A change in the cash reserve ratio (CRR) is not expected in the December MPC meeting. However, the RBI may consider either a CRR cut (even if for a finite period) or open market operations (OMO) in the coming months, based on prevailing money market and financial market conditions.

Finally, of late, the INR trajectory also offered comfort along with better FII flows, partly reflecting some of the recent policy initiatives (Eg., measured trade restrictions, INR settlement in external trade, greater flexibility for banks as regards non-resident deposits) apart from measured forex market intervention.

Overall, the central bank remained proactive and cautious to guard the economy against inflationary spirals and global spill-overs even if that meant a somewhat slower recovery immediately as they remained committed to financial stability and long-term sustainability of growth. Despite another likely 25bps repo rate hike in December, need for further tightening in the coming months might be limited, with possibilities of a moderately supportive stance on liquidity from the RBI.

The author is chief economist and head of research at Bandhan Bank and thanks Jamal Shahid for his assistance. Views are personal.

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