The Reserve Bank of India’s (RBI) shift to prioritising inflation ahead of growth in its latest Monetary Policy Statement announced on Friday is not surprising and is as it should be. The Monetary Policy Committee (MPC) has stayed its hand yet again on a repo rate hike but the nuanced change in stance to “remain accommodative while focusing on withdrawal of accommodation” heralds a gradual return to normalcy from the policies followed in the last two years. The Russia-Ukraine conflict is posing unforeseen challenges to the economy and the impact of this event on the global growth-inflation dynamic is still unfolding. In an effort to prepare the ground for a change in the rate cycle in the next few months the central bank has restored the Liquidity Adjustment Facility (LAF) corridor to pre-pandemic levels of 50 basis points. This has been done by instituting a new collateral-free window — Standing Deposit Facility (SDF) — for banks to deposit their overnight surpluses at 3.75 per cent. Given that MSF, which is at 4.25 per cent, and SDF will be available on-tap at the banks’ discretion and will hereafter make up the floor and ceiling of the LAF (rendering the reverse repo somewhat irrelevant) this has the effect of a back-door rate hike. This measure, taken with RBI’s plans to withdraw the post-pandemic liquidity overhang of ₹8.5 lakh crore in a calibrated manner, offers sufficient signals that rate hikes are on the way. This is perhaps why the policy has sent market yields across tenures spiralling up on Friday, with the benchmark 10-year security well past 7 per cent.

The language of the MPC has also changed subtly, to capture the shift in goalposts from prioritising growth to targeting inflation. While the RBI has been conservative in pegging real GDP growth at 7.2 per cent for FY23 (private forecasters still expect 7.4-7.8 per cent), its inflation forecasts appear a tad optimistic. Despite a $100 per barrel assumption on the Indian crude oil basket, retail inflation is projected to average 5.7 per cent in FY23 while the market is not so sanguine and expects it to breach the MPC tolerance level of 6 per cent. RBI is right in its view that the recent inflationary bout is triggered more by supply constraints than demand and therefore needs ‘proactive supply management’. But the central bank needs to brain-storm with the government to come up with some concrete supply-side interventions that can prevent a rising inflationary trend from taking root.

The policy statement also seems to downplay growing risks to India’s balance of payments and exchange rate from the global monetary tightening coinciding with strong risk-off sentiment among global investors. During previous global crises such as the taper tantrum, shrinking rate differentials between India and Western markets triggered a capital exodus and ended up forcing RBI’s hand on sharp rate hikes that proved disruptive to the economy. Though India’s exports, economy and forex reserves are in a far stronger position today, vigilance is needed to pre-empt a repeat of that episode.

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