The Reserve Bank must maintain its hawkish stance

Not only the WACMMR, the balance under the liquidity adjustment facility (LAF) has also moved into deficit territory since September. Of course, the two variables tend to move in line with each other. An increase in the WACMMR reflects tighter monetary policy, which means lower surplus or higher deficit under the LAF window. The LAF deficit has increased to more than ₹1 trillion in the last two weeks of November, before easing to ₹49,000 crore on 30 November.

One may wonder about the need for such a stealth rate hike. If the RBI wants to keep interest rates higher and liquidity tighter, then it is always more effective to do it in a direct and transparent manner. It would also bring more certainty to economic participants and make the central bank’s intentions very clear.

Add to this, the rising concerns of the RBI about the exceptionally strong and resilient growth in unsecured consumer loans (personal loans, excluding housing, vehicles, education and loans secured against gold and jewellery), and the need for loosening disappears entirely. While the RBI management had started voicing concerns in this regard four-five months ago, few concrete measures were announced in November to restrict growth in unsecured consumer loans by raising the risk weights on such loans.

Amid weak income growth and strong spending, rising borrowings and falling savings are two sides of a coin. The confidence of Indian households is reflected in their strong spending, which, unfortunately, fails to match with income patterns.

These behaviours are also visible in the bimonthly consumer confidence surveys (CCS) published by the RBI. While 50% of the respondents expect higher income growth a year down the line, as many as 70% of respondents share this optimism on spending. This spread (between income and spending optimism) has remained very stable during the entire post-covid period. Consequently, consumer leverage has increased and their total savings have gone down. About a decade ago, one year’s worth of household savings was sufficient to pay off an entire household’s debt. In FY23, it would take almost two years of savings to clear the entire household debt in India.

All-in-all, India’s monetary policy remains hawkish, and we expect it to be continued this week as well. Although an explicit rate hike to bring the policy interest rates in line with the market rate (WACMMR) looks difficult and unexpected (especially after four pauses), it would not be totally irrational.

It is also important to understand that macro-prudential measures could be more effective than direct rate hikes in restricting growth in unsecured consumer loans. This is because although the traditional indicators of an overheating economy—inflation and current account deficit—are well-behaved as of now, the MPC would do well to remain cautious at this stage, considering the facts that the combined fiscal deficit in FY24 could be 9% of gross domestic product (GDP)—unchanged from FY23—and household financial savings collapsed to a 47-year low of just 5.1% of GDP in FY23 (and are likely to remain subdued in FY24 as well).

In any case, with better-than-expected real GDP growth for the third successive quarter in Q2 FY24, and an average growth of 7.7% in H1 FY24, there is absolutely no worry over growth as of now. Even with weaker growth (of, say, 5-5.5%) in H2 FY24, India’s real GDP growth will be closer to 6.5% for FY24, which is reasonably decent.

Overall, we expect the MPC to keep interest rates unchanged and continue to sound hawkish. We do not think this is the time to let our guard down. At the same time, we do not even recommend a change in stance, because moving to ‘neutral’ from ‘withdrawal of accommodation’ may send a signal of monetary easing, which would be in stark contrast to other signals and, thus, must be avoided.

Nikhil Gupta is chief economist, MOFSL (Motilal Oswal Financial Services Ltd) Group .