That the Monetary Policy Committee (MPC) of the Reserve Bank of India will increase interest rates for the fourth consecutive time was almost a given, and the 50 basis points — one basis point is one hundredth of a percentage point — hike which was announced on September 30 is in line with analyst estimates.
The more awaited parts of the MPC resolution were RBI’s growth and inflation forecasts, and its take on the volatility in international currency and financial markets, and their impact on the Indian economy. On these counts, MPC has struck a cautionary note, while underlining that the domestic economy remains relatively resilient and monetary policy will continue to remain vigilant to contain inflation while continuing to support growth.
The MPC increased the policy rate by 50 basis points on September 30 in a five-one decision (one MPC member voted for a hike of 35 basis points) to 5.9%. This means that the central bank has increased policy rates by 1.9 percentage points from the 4% level at which it was in April 2022. While the cumulative pace of rate hike is among the sharpest in the past few years, governor Shaktikanta Das underlined that the real rate (after adjusting for inflation) was still lower than what it had been in the past. “Thus, even as the nominal policy repo rate has been raised by 190 basis points so far (including today’s increase), the policy rate adjusted for inflation trails the 2019 levels. The overall monetary and liquidity conditions, therefore, remain accommodative and hence, the MPC decided to remain focused on withdrawal of accommodation”, Das said in his statement. The repo rate (or the policy rate) is that at which the central bank lends to commercial banks.
While MPC has slashed projected growth rate for 2022-23 by 20 basis points from its 7.2% projection in August, a look at the quarterly numbers suggests that it actually believes economic activity will gain momentum in the second, third and fourth quarters of the current fiscal. Quarterly GDP growth projections for September 2022, December 2022, and March 2023 have been increased from 6.2%, 4.1%, and 4% in the August MPC resolution to 6.3%, 4.6%, and 4.6% in the latest resolution.
“The government’s continued thrust on capex, improvement in capacity utilisation in manufacturing and pick-up in non-food credit should sustain the expansion in industrial activity that stalled in July. The outlook for aggregate demand is positive, with rural demand catching up and urban demand expected to strengthen further with the typical upturn in the second half of the year”, the MPC resolution said. To be sure, the biannual Monetary Policy Report released by RBI suggests that the economy will lose growth momentum in 2023-24 compared to 2022-23 with projected GDP growth expected to come down to 6.5% next fiscal. The median projection of professional forecasters for 2023-24 GDP growth rate is 6.1%, suggesting that the slowdown in growth could be more than what the RBI’s baseline projection assumes.
As far as inflation is concerned, the forecast for annual inflation has been kept unchanged at 6.7% and the benchmark inflation rate, as measured by the Consumer Price Index (CPI) is expected to stay above the target range of 6% until the December quarter. While noting that the moderation in international commodity prices will help the domestic inflation situation, the MPC resolution highlighted the uncertainty from the globally volatile environment and appreciation of the US dollar feeding into imported inflation pressures even as price pressures continue to remain elevated. “Core CPI (i.e., CPI excluding food and fuel) inflation remained sticky at heightened levels, with upside pressures across various constituent goods and services”, the resolution noted.
While the MPC resolution has highlighted the downside risks to the economy due to increased global volatility, the central bank underlined the resilience of the Indian economy. “Despite this unsettling global environment, the Indian economy continues to be resilient. There is macroeconomic stability. The financial system remains intact, with improved performance parameters”, Das said, adding that “buffers built over the years have stood us in good stead”.
“The movement of the Indian rupee (INR) has, however, been orderly compared to most other countries. It has depreciated by 7.4 per cent against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers”, the governor added even as he maintained that the rupee is a free floating currency and RBI had no preferred exchange rate target.
Experts believe that the central bank had no other option but to raise interest rates given the external environment. “The MPC delivered 50 bps hike in line with expectations. Clearly, the fast-evolving world order and consistent repricing of Fed’s outsized hikes are strong-arming the EMs. This painful adjustment has not spared RBI either, which realised the net cost of a supposed soft signalling via shallow hike could be higher than a larger hike of 50bps. This exposes the instability inherent with the classic EM central bank trilemma: one cannot have a stable currency, unfettered capital flows, and independent monetary policy all at the same time”, Madhavi Arora, lead economist, Emkay Global Financial Services, said in a note.
“Going ahead, we believe that if the global market headwinds become a source of material risk to growth or inflation, the Reserve Bank is likely to react accordingly. While we acknowledge the risks of more rate hikes, we wait for more details on economic data and inflation before charting out the path for future monetary policy”, Rahul Bajoria, MD & head of EM Asia (ex-China) Economics, Barclays said in a note.