Home / Opinion / No change in stance, more light on forex depletion

There weren’t any major surprises in the credit policy announced by the governor of the Reserve Bank of India. Intense debate on the possibilities in the policy were flagged in the run-up to this announcement as all analysts and economists tried reading into the mind of the central bank. The summary of MPC meeting indicates that almost all announcements were in accordance with the market expectation, with a possible deviation being only on the stance. The market can take solace from the fact that the RBI has assured that in its view, the economy is resilient and that inflationary pressures, caused by a variety of factors would stay for this year.

The RBI has increased the repo rate by 50 bps, which was expected given that in the prelude to this announcement, the governor spoke of the third shock that we are witnessing i.e. central banks across the world raising rates to tackle inflation. The other two shocks were covid and Ukraine war. Hence, while the impression so far was that policy is normally driven by domestic considerations, there has been an indirect reference made on the approach taken by the Fed and ECB which affect us through the investment route and also add to currency volatility. This being the case, the forward guidance provided by the major central banks is directed towards more aggressive increases in policy rates. The implication is that this may not be the last rate hike for us and that there could be more coming, which can take it to 6.4-6.5% by March. The one-year overnight indexed swap (OIS) was pointing at a number in the range of 6.5-6.75% for quite some time. The overall inflation target for the year remains unchanged at 6.7% as the pressures remain on food even while producers of manufactured goods are still in the process of passing on higher input costs to the consumers. The red flag is, however, more on the agricultural side where lower output of rice and pulses as well as the delayed withdrawal of monsoon can impact inflation. Hence the onion and tomato syndrome has to be watched out for where late withdrawal of monsoon damages crops and causes sharp increases in overall inflation.

The GDP growth forecast has been lowered marginally to 7% which is due to the statistical realignment which has taken place after the first quarter number came in lower than the RBI’s expectation. The RBI has actually increased its projections for Q2, Q3 and Q4 relative to its expectations in the August policy and backed it up with a strong story line on how the economy is faring based on all high frequency data such as PMIs, consumption, capacity utilization, import of non-oil goods etc. Therefore, for all practical purposes, the indication is that the growth trajectory is on the expected path and presently, there is no reason to believe that anything can upset the apple cart. This is premised on consumption continuing in Q3, which is the post-harvest and festival season when consumerism peaks in both rural and urban India.

The other part of the commentary which the market was looking at is the stance. Here, there may have been a surprise because the concept of withdrawal of accommodation will continue. It was felt that since the daily surplus liquidity had dwindled to a deficit at times would provoke some affirmative action by the RBI in terms of announcing Open Market Operations (OMOs). However, the RBI has explained that the temporary distortion was more due to advance tax payments and as the government will spend more aggressively in the second half due to habit, liquidity would be back to the above 2 trillion mark. Therefore, the stance has not really changed as there is space for further ‘withdrawal’.

Is the market comforted by the stance on the currency? Here only time will tell as the RBI is comfortable with the level of reserves and has reiterated that it has no number in mind and is more worried about volatility. The critical statistic that has been mentioned here is that in the fiscal year, of the $70 billion drop in forex reserves, two-thirds has been due to valuation of reserves. This should be comforting to the market as it was not quite clear if the RBI has been selling large quantities of dollars in the market to steady the rupee.

The RBI has been steadying the ship through inclement weather in the last three years or so ever since the pandemic began. Shocks have come from unexpected quarters which has made policy formulation tricky as the goal post has shifted from inflation to growth to inflation. The calibrated approach has ensured there have been no ugly shocks which is how it should be.

Madan Sabnavis is chief economist at Bank of Baroda and the author of Lockdown or Economic Destruction.Views are personal.

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