Monetary policy stance: Keeping it real

The MPC has delivered about 300 bps in policy rate tightening in 2022 - the call money rate has risen from 3.3 per cent to 6.2 per cent. The RBI should deliver one more rate hike in February 2023 and then hope to take a long pause at 6.5 per cent. Meanwhile, the policy stance will turn neutral to moderately restrictive in 2023, not because the RBI is going to sharply increase policy rates but instead, due to fall in inflation towards 5 per cent. This means the real policy rate would, on prospective basis, stay above 1 per cent through next year, which is read as restrictive.

India also needs higher real interest rates to finance growth.  | Photo Credit: PTI

India also needs higher real interest rates to finance growth. Robust profitability of firms and sustained urban jobs’ growth suggests that demand for capital is likely to rise next year as the private sector begins to lever up. After a long gap since FY19, we will see credit intensity (measured as bank credit growth over nominal GDP) rise above 1.0x towards long-term average of 1.2x.

India is already a capital deficient country where the deficit is rising (that is 3 per cent+ CAD as % of GDP), therefore, to accommodate additional commercial capital demand, we need to see a combination of higher cost of capital and reduced borrowing by the public sector to attract external funds.

Accommodative stance

So far, the government is taking an accommodative stance by spending all the revenue bounty from the unexpectedly large nominal growth and tax buoyancy this year. Doing the same next year runs the risk of increasing cost of capital for the private sector beyond desire.

“What about the multiplier benefits from public capex needed to sustain growth? Is it prudent to sacrifice momentum on this front?”- this a fair question. This is where fiscal finances, the benchmark risk-free rate and country risk premium would all be well-served if policymakers can, overtime, delink public capex requirement from government balance sheets.

Now would be the perfect opportunity to unlock value in cash-generating public assets to fund further expansion; it is the right time for the asset monetisation pipeline drawn out in FY22 to see implementation. The ₹25,000-crore balance sheet of the new DFI, National Bank for Financing Infrastructure and Development (NBFID) should become the source of leverage for public capex over the next decade. Leveraging Government of India balance sheet to fund capex is the path of least resistance with weakest filters on commerciality and hence the call for discipline.

Banking on domestic demand

India’s domestic demand will steadily build momentum in 2023 and by mid next year, should be strong enough to offset weakness in external demand. Our economy will be expanding at a time when the rest of the world is slowing down, this demand gap creates financing challenges which is why RBI would like to keep real interest rates slightly elevated.

It is tempting to believe that India’s eminence would drive hordes of foreign investors into the country thereby solving our external funding challenge and domestic liquidity tightness in one fell swoop. While the emerging market investing universe may have shrunk, capital surplus countries will themselves see surpluses shrink due to weak real income growth and higher financial loading. Under these conditions, India needs to portend macro-stability along with already evident high real return potential to make CAD eminently financeable.

(Prithviraj Srinivas is ED - Economist, Institutional Equity Research, Axis Capital Limited)

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