Repo rate hike may still be three-four quarters away

MARZBAN IRANI

There has been a lot of volatility in the fixed income market in the last one-and-a-half years on the domestic as well as global fronts amid the pandemic. As the pandemic spread across the world, central banks cut rates and infused liquidity into the market.

By December 2020, when the world felt it has overcome the problem, the second wave struck. As we come out of the second wave, governments all over the world are cautious about the Delta wave.

In this backdrop, as members of the Monetary Policy Committee (MPC) go into a huddle between August 4 to 6, they will size up the retail inflation reading, which has been above the MPC’s upper tolerance level of 6 per cent in May and June, and the anaemic growth.

The members are seen voting in favour of keeping the repo rate unchanged and persisting with the accommodative policy stance to nurture economic recovery and sustain it.

Once growth gains momentum and is back to the pre-pandemic levels, the MPC is expected to gradually drain the excess liquidity from the financial system, then change the policy stance and, finally, start hiking rates.

Given that the MPC is committed to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, a rate hike may be three-four quarters away.

Focus on growth

So, in the upcoming bi-monthly monetary policy review, the MPC is expected to stay focussed on growth since the economy is opening up gradually and, by October policy, the RBI may react in line with global rates, which may start inching upwards. The 10-year yield is expected to trade in the range of 6.00-6.25 per cent in the near term and may start moving upwards gradually.

There was a lot of debate when inflation numbers started inching upwards during the pandemic. How can inflation increase when there is a slowdown? In the backdrop of two consecutively high retail inflation readings above 6 per cent (MPC has a comfort level at 4 per cent), RBI Governor Shaktikanta Das emphasised that these numbers are transitory in nature, and the headline number is expected to come below 6 per cent, going ahead.

The main culprit driving the rising inflation numbers was higher commodity prices, which pushed the input prices upwards, and it further percolated into prices of end products. If input prices keep increasing, firms will pass on this increase to end consumers as demand recovers after the second wave.

At its last meeting, OPEC decided to increase oil production, which has helped bring oil prices down. However, at about $73 a barrel, oil prices continue to be higher than last year’s $45. India, being a net importer of oil, will bear the brunt.

Also, the service industry (contact-intensive sector), which faced severe slowdown due to the pandemic, might see price increase when it opens up. Monsoon will play a key role in food inflation since July is the month when one-third of sowing takes place normally. Hence, most of the sowing will depend on monsoon, going ahead.

Q2 expected to be good

Growth numbers have been volatile since March 2020. As the second wave abated faster than feared, economies all over the world started opening-up gradually. Developed countries with faster vaccination roll-out are opening-up much faster than emerging markets, which are struggling with vaccination due to supply constraints.

On the domestic front, by mid-July 2021, high frequency indicators such as power demand, E-Way bills, power consumption and mobility index were showing positive signs with the gradual unlocking of States.

Government spending is expected to be good even as private investments take some time to pick up. Exports will be the silver lining that will balance the shortfall in growth numbers.

After the second wave, there has been a sharp increase in unemployment rate in rural areas. The MNREGA scheme of the government will play a key role in rural employment and bringing rural consumption back on track.

Overall, the July to September 2021 quarter is expected to be good based on pent-up demand, vaccination drive, favourable policy initiatives in the past and global growth.

Fiscal policy

MPC was the prime moving force last year after Covid outbreak, but going ahead, rate cuts will be less effective. Hence, the baton passes on to fiscal policy from the MPC. It has become imperative for the government to provide employment, food and health-related support to vulnerable sections of the society, and continue with aggressive disinvestment when the equity markets are high.

The downside risks include limited capex plans, partial restrictions in key States and concerns over the third wave, which may impact the industrial as well as service segments. Prolonged economic recovery, if the third wave hits, along with no significant improvement in current vaccination drive due to supply constraint, remain major unforeseen risks.

(The author is CIO-Fixed Income, LIC Mutual Fund. Views expressed are personal)

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