Opinion: Inflation not yet off priority

The sharp measures outlined in the December MPC review clearly indicate that fight against inflation will continue.

By Dr K Srinivasa Rao

Hyderabad: The Reserve Bank of India (RBI) voted to stay in tune with its counterparts of major economies by raising the repo rate by 35 basis points to 6.25%. Resultantly, the standing deposit facility (SDF) is reset to 6% while keeping the fixed rate reverse repo intact at 3.35%. Liquidity window marginal standing facility and bank rate move up to 6.5%.

The impact would shoot up borrowing costs for banks and businesses that are pegged at floating rates of interest. Depositors will stand to benefit with the interest curve moving their way. The external benchmark lending rates linked to the repo rate will go up instantly while there will be some lag period in resetting the Marginal Cost of Funds based Lending Rates which banks have to do to protect their margins.

No Surprise

There is no surprise in the move except that the repo rate may hit its high too soon warranting a pause sometime beginning FY24 by when inflation should return to its glide path (4% /-2% to range between 2% and 6%). The last high repo rate in recent times was 6.5% in January 2019.

The mild tone of aggression in rate hikes since May 4 and transparent communication by the central bank reflect its resolve to tame inflation not only today but also to ensure that the impending spillover risks do not disrupt its softening trajectory. Therefore, despite CPI inflation coming down to 6.77% in October compared with a high of 7.79% in April 2022, the RBI is keen on tackling the surge in core inflation (excluding food and energy) as this could weaken growth impulses and cause pain to millions of people at the bottom of the pyramid.

Considering the external risks and protracted uncertainties in global energy prices, the headline inflation (including food and energy) stays projected at 6.7% for FY23 with some tweaking to recede below the upper edge of RBI target of 6% during Q1 of FY24 and then to 5%. But such a medium-term inflation outlook is exposed to heightened upside risks due to geopolitical tensions, financial market volatility and the rising incidence of weather-related disruptions.

Growth Pathway

The growth potentiality could be gauged from RBI surveys where consumer confidence has improved further. Manufacturing and infrastructure are optimistic about the business outlook. Services also expect activity to expand. It can be further vouched from the fact that non-food bank credit increased by Rs 10.6 lakh crore during April-November 2022 as compared with an increase of Rs. 1.9 lakh crore last year. The total flow of resources to the commercial sector expanded by Rs 14.7 lakh crore during FY23 (up to Nov) as compared with Rs 6.8 lakh crore in the same period of FY22. The government’s focus on capex spent and infrastructure investments could be adding to the potential growth of different sectors.

Growth nodes are firming up in farm, services and manufacturing sectors evidenced by the rise in Purchasing Managers’ Index (PMI) broadening the path of the revival of the economy. It needs greater support from financial intermediaries to provide working capital to explore its potential. The RBI expects the growth to be driven primarily by private consumption and investment potentiality where supply-side efficiencies and timely access to resources will have a bigger role than input costs.

External Sector

As exports are slowing following a slowdown in host countries, the current account deficit (CAD) is poised to widen to 3% of the GDP during FY23. But foreign portfolio flows have resumed in recent months recording a positive growth of $11.8 billion from July to 5 December 2022, led by equity flows.

It is noteworthy that the net foreign direct investment (FDI) flows too have remained robust to reach $22.7 billion during April-October 2022, from $21.3 billion in the corresponding period last year despite intense reverse flows witnessed by emerging markets due to aggressive rate hikes in the West.

As a result of the measures announced by the RBI on July 6 to enhance forex inflows, new external commercial borrowing (ECB) agreements have been entered into for $8.6 billion. The size of forex reserves has gone up from $524.5 billion on October 21 to $561.2 billion as on December 2, covering around nine months of projected imports for 2022-23. These potential signages will work in future to boost growth.

Task Ahead

The sharp measures outlined in the December MPC review clearly indicate inflation control as RBI’s priority. Market players can take a cue from the policy dispensation that they need to work out business strategies to be able to operate amid elevated input costs in the near term and conserve borrowings to stay competitive.

Financial intermediaries, more importantly, banks, will have to lend a supportive hand to the industrial and commercial sectors with fine-tuned assets and liability products by efficiently recycling scarce deposit resources. With liquidity stress brewing, many banks are floating specific bonds to fund lending operations. Banks should better collaborate with the borrowing community to enforce faster recovery of loans and ensure quick lending to entrepreneurs for enhancing its multiplier impact on GDP growth. More than the cost of borrowing, timeliness is important for entrepreneurs.

Entities consistently aiming for improved operational efficiencies could be the winners in the long run when the economy harnesses its full potential to move towards achieving its avowed objective to enter the league of developed economies in the next few decades. Near-term hurdles of inflation need to be tackled head-on to create the kind of buoyancy needed to steer growth.

(The author is Adjunct Professor, Institute of Insurance and Risk Management [IIRM], Hyderabad. Views are personal)