RBI Monetary Policy: Rate Hike Quantum Set To Ease

The MPC September policy minutes showed two members hinting at a pause in December.

<div class="paragraphs"><p>The headquarters of the Reserve Bank of India in Mumbai. (Source: BQ Prime)</p></div>
The headquarters of the Reserve Bank of India in Mumbai. (Source: BQ Prime)

In the September policy review, the Monetary Policy Committee had delivered another ‘new normal’ repo rate hike of 50 basis points, along expected lines, albeit with a non-unanimous vote of 5:1. Moreover, it had maintained its stance (also with a 5:1 vote), and the CPI inflation projection for FY23 unchanged at 6.7%, while paring the baseline forecast for FY23 GDP growth to 7.0% from 7.2%.

The subsequently released minutes of the MPC’s September policy review had revealed divergent views of its members, with two of the external members hinting at a pause in December.

Domestic data since then has been mixed. The headline CPI inflation hardened from an already uncomfortable 7.0% in August to an unnerving 7.4% in September, before reverting to 6.8% in October, led by a base effect-led drop in the food inflation, especially vegetables. It nevertheless stayed firmly above the 6.0% upper threshold of the MPC's medium term forecast range of 2.0-6.0% for the tenth consecutive month, cementing the case for another rate hike in December.

Some risks cloud the near-term inflation outlook, such as supply disruptions for certain perishables owing to excess rains, a robust demand for services and some evidence of a transmission of higher headline inflation into categories such as housing rentals.

However, the total area sown under the ongoing rabi season has risen by 7.2% year-on-year as on Nov. 18, driven by wheat, jowar and mustard, auguring well for prices going ahead. Moreover, a high base is expected to aid in further softening the year-on-year CPI inflation to ~6.0-6.2% in November 2022, with the first sub-6% prints likely to emerge in the coming quarter.

On the growth front, the awaited GDP growth print for Q2 FY23 will be published shortly prior to the December 2022 Monetary Policy review. ICRA has projected the year-on-year growth of the GDP at basic prices (at constant 2011-12 prices) in Q2 FY23 at 6.5%, higher than the MPC’s forecast of 6.3%. This represents a base effect-led halving from the 13.5% recorded in Q1 FY23. However, the growth in the GDP over the pre-Covid levels is expected to double to around 8% in Q2 FY23 relative to the 3.8% seen in the previous quarter, with a widening of the economic recovery.

ICRA estimates the sectoral growth in Q2 FY23 to be driven by services (+9.4%), with a rather subdued trend foreseen for the industry (+2.0%), and agriculture, forestry and fishing (+2.5%).

Separately, the year-on-year growth in the ICRA Business Activity Monitor—an index of high frequency indicators, stood at 7.4% in October 2022, reverting to single digits after a gap of six months.

The moderation in the YoY growth from 13.6% in September 2022 was largely on account of the early onset of the festive season in 2022 vis-a-vis 2021, and the consequent shift in the holiday calendar.

While the month-on-month performance of the constituent indicators was mixed in October 2022, the index was 18.3% higher than the pre-Covid levels, indicating a continued broadening of the recovery.

The early trends displayed by various high frequency indicators for November 2022 are healthy, although this partly reflects the subdued base owing to the impact of higher festive holidays in November 2021.

The global context continues to be mixed. Geopolitics remains challenging and recessions are looming in various advanced economies. However, the latter has coaxed the prices of some commodity to recede.

With a lower-than-expected U.S. CPI inflation print, the concerns regarding the pace of rate hikes that will be forthcoming from the U.S. Federal Reserve have moderated. This has cooled the 10-year U.S. Treasury yield and transmitted to a softening in the 10-year G-Sec yield as well.

Simultaneously, a sharp pullback in the Dollar Index has helped the INR to strengthen against the U.S. Dollar in the recent weeks, offering some relief from the relentless depreciation witnessed for much of this year.

India’s forex reserves have also jumped to $545 billion as on Nov. 11, 2022, from the recent low of $525 billion seen on Oct. 21, 2022.

With the CPI inflation remaining above the MPC’s 6% tolerance level in October 2022, we believe that another rate hike is certain in the December 2022 policy to prevent inflationary expectations from un-anchoring.

However, given the moderation in CPI inflation in October 2022 and the expectations of a further dip in November 2022, we expect the size of the hike to be restricted to 35 basis points, lower than the 50 bps seen in the last three reviews. Moreover, we anticipate this vote to be non-unanimous, which may lend itself to a neutral tone regarding the pace and timing of future rate hikes.

We are currently projecting GDP growth at around 5% in both H2 FY23 and H2 FY24, periods which are assessed to be relatively free from base effects.

A gloomy global outlook poses a key downside risk to our baseline forecasts, which are already below our projection of the potential GDP growth for the Indian economy.

Once inflation falls within the tolerance zone, further rate hikes should be data-dependent, in our view, with the balance tipping slightly in favour of avoiding a growth sacrifice.

Aditi Nayar is chief economist at ICRA Ltd.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.