Given the growth-inflation trade-off, Governor Das took the right call, particularly in the context of global slowdown
By Dr Manoranjan Sharma
Hyderabad: The Reserve Bank of India (RBI) was widely expected to raise its benchmark rate for the seventh consecutive meeting by 25 bps to a seven-year high of 6.75% on April 6 with the distinct possibility of more hikes to contain inflation within its comfort zone. Almost all central banks hiked rates since April 2022 with the cumulative hikes being US 450 bps, Hong Kong 450 bps, Canada 400 bps, UK 350 bps and Australia 350 bps.
Successive rate hikes began with a 40 bps hike from 4% at an off-cycle meeting in May 2022, its first rate increase in nearly four years and, therefore, “it is now necessary to evaluate the cumulative effect of rate hikes”. Early signs of a slowdown were visible in bank credit growth which decelerated to 15.7% year-on-year as of March 10, 2023, easing from a decade high of 17.9% in October 2022.
Since the RBI had already raised rates by 250 bps since May 2022, it refrained from any such hike even though inflation continues to breach the tolerance level of 6 %.
Pause not Pivot
This decision would provide relief to borrowers in rate-sensitive sectors like real estate, including residential complexes, passenger cars and commercial vehicles with the home loan and other EMIs unlikely to rise. Further, large debt companies, growth stocks, small and mid-cap space companies, and specific sectors, viz, consumer durables and real estate, would not be adversely impacted. Business sentiments will improve by containing the rise in borrowing costs and thus augur well for the broad-based Indian economy. Any further hike in the benchmark repo rate at this juncture would have affected India’s economic growth even as domestic demand impulses remain healthy.
However, the cost of wholesale borrowings in money markets could rise because of the RBI’s decision to reduce surplus liquidity. Incidentally, this status-quoist decision of the RBI is in line with the decision of some other central banks in the region, including Indonesia, South Korea and Malaysia.
Further Hikes
The Monetary Policy Committee (MPC) remains focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth. The RBI Governor did not explicitly say that there would be a rate hike post the next MPC meeting. But reading between the lines, the policy statement is strongly suggestive of the fact that there could be one more hike because the “war against inflation will continue until durable decline in inflation closer to target is seen”.
The Governor said, “the MPC unanimously decided to keep rates unchanged in this meeting with readiness to act if the situation so warrants. The MPC will not hesitate to act as needed in future meetings”. While keeping the interest rate intact, the Governor stressed that core inflation remains sticky. Hence, the repo rate could reach 6.75% with a possible final 25 bps hike in the first half of FY24.
Inflation, GDP
High retail inflation since December 2022, spike in food inflation and persisting high core inflation across many goods and services cause concern and consternation. While headline inflation (total inflation within an economy including prices of food, fuel and other commodities) is likely to moderate in FY24, the inflation trajectory would be a function of both domestic and global factors, viz, global dynamics, record rabi foodgrain production, volatility in crude oil prices with potential high imported inflation risks and El Nino.
India’s real GDP is likely to have grown by 7% in 2022-23 and economic activity remains resilient to global spill-overs. The banking turmoil in some countries and the volatility in the rupee are being closely monitored by the RBI. The RBI marginally revised upwards the economic growth projection for the current fiscal to 6.5% from 6.4%. Traction in high-frequency indicators, such as fuel consumption, automobile sales, PMI manufacturing and services, and GST collections is reflected in higher annualised growth rates and sequential improvements. Despite protracted geopolitical tensions, tight global financial conditions and global financial market volatility, FY24 GDP growth has been projected at 6.5%. Significant narrowing of current account deficit in Q3 to 2.2% from 3.7% in Q2; surge in foreign exchange reserves to over $600 billion and fiscal consolidation augur well.
Rupee Depreciation
The rupee’s relatively lesser depreciation in the calendar years 2022 and 2023 (in line with the decline in most major currencies, the rupee depreciated by 7.8% in FY23 vis-à-vis a more pronounced depreciation of Chinese yuan, South Korean won, Malaysian ringgit and Philippine peso) reflects the strength of domestic macroeconomic fundamentals and the resilience of the Indian economy to global spill-overs from recent developments in financial markets in the US and Europe.
These uncertainties, together with spiralling inflation, have led to financial market volatility, reflected in sizeable two-way movements in bond yields, a fall in equity markets, and the US dollar no longer being the global default currency. While these spill-overs imperil short-term investment flows to emerging markets, including India, Indian banks remain well-capitalised.
Other Measures
An important developmental measure relates to developing an onshore non-deliverable derivative market. Regulatory and supervisory measures attempt at enhancing the efficiency of regulatory processes, developing a centralised web portal for the public to search unclaimed deposits, and instituting a grievance redress mechanism relating to credit information reporting by credit institutions and credit information provided by credit information companies.
In respect of payment and settlement systems, operation of pre-sanctioned credit lines at banks through the UPI is welcome. All these contextually significant measures would enhance the strength and reliance of the Indian financial sector.
In sum, given the growth-inflation trade-off, RBI Governor Shaktikanta Das took the right call by recalibrating the monetary policy with effective transmission to financial markets, particularly in the context of the globally synchronised slowdown to less than 3% this year, with India and China accounting for half of the global growth in 2023.