Thinkpad: Livin' On A Prayer

Happy weekend.

This week was a Thinkpad kinda week — all about central banks. Two central banks in particular — the U.S. Federal Reserve and the Reserve Bank of India. Both 'livin' on a prayer' in some ways, along with the markets.

The RBI and the Monetary Policy Committee met amid calls from the market to step up the pace of normalisation, as inflation risks swirl. Instead the central bank maintained status quo and struck a dovish note.

Indulge us as we get into the weeds for a bit. The market was ready for a reverse repo rate hike and it would have made little real difference since the effective rate at which funds are being absorbed has already risen via the variable rate reverse repo auctions. In fact, at this meeting the RBI further reduced the role of the fixed rate repo by saying that the 14-day variable rate auctions will be the key liquidity management tool and that the fixed rate liquidity absorption window will only be available post market hours.

The RBI may argue this makes the reverse repo rate largely irrelevant. In that case then, why not normalise the interest rate corridor and let the reverse repo rate move in conjunction with the main policy repo rate as it once did?

But, perhaps, any such hike would have changed the narrative on monetary policy. 'RBI raises interest rate' would have been a popular headline and maybe the central bank didn't want that yet. It probably also didn't want to roil bond markets any more and the dovish policy helped bring down bond yields which had spiked after the budget. The rupee, though, weakened.

The bigger question is whether the RBI is underestimating inflation at 4.5% for FY23. The central bank may be banking on lower food prices, from items like pulses and edible oils, due to supply side interventions. In addition, it may be building in still weak demand and a fall in global commodity prices. A drop in inflation expectations may have supported the central bank's call, alongside weakness in industrial output, which may be adding to fears that the growth recovery is fragile.

We'll know in about six months whether the central bank's call was right.

In the meantime, we wouldn't blame you for humming some Bon Jovi: ♫ Take my hand, we'll make it I swear...Woah... livin on a prayer...♫ 🎸

Over in the U.S., inflation has risen to 7.5%. There is no ambiguity that the U.S. Federal Reserve will raise rates in March. The debate has shifted to the quantum of that hike. The probability of a 50 basis points hike to kick off the cycle has risen and there has been chatter of an emergency move. But the Fed may not be in favor of any of that yet, writes Bloomberg News. Seven rate hikes are now being talked of over the course of this year.

The rest of the world is waiting to see how markets reacts. There is hope and prayer that it won't go the way of 2013.

As the Fed and many other central banks move towards tightening, does India need to fear being seen as an outlier? Could that weigh on foreign inflows and the currency?

There are views that it might not but prayers are a large part of those views too, we suspect. India is certainly much stronger, macro economically speaking, today than in 2013 but to those saying that India has decoupled from the world, a reminder of an evergreen YV Reddy quote — decoupling is contextually convenient but inherently illogical.

Here's hoping the central bankers — globally and in India, get it right.

♫ We've got to hold on, ready or not...you live for the fight when it's all that you've got..♫🎸

Next week will likely be all about the Life Insurance Corporation IPO as investors parse through its draft prospectus. Is there a way to connect the dots between the LIC IPO, the quest for lower bond yields and a stable rupee? Raghav Bahl gives us something on chew on with this piece.

Till next week.