The MPC’s “action will be measured and calibrated,” said RBI Governor Shaktikanta Das while responding to a question after the last meeting of the Monetary Policy Committee in August, on whether the RBI would front-load rate hikes as the real rates are still negative.
As we gear for the next MPC meeting this month-end, many economists believe that the RBI will again hike rates, with only the quantum being open to speculation. This line also draws inspiration from the address of Jerome Powell, Chairman of the US Federal Reserve, at the Jackson Hole symposium where he left no one in doubt about where the Fed was headed. With the US inflation (8.5 per cent) still above even our levels, rate hikes there seem inevitable — in a bid to curb demand in a formalised economy.
But should a largely informalised India follow the US or the West in hiking rates mindlessly? Particularly when it has been clarified by the RBI that our rate action is dictated by domestic factors and not by what is happening on the external front. So, a rate hike for the rupee just because the US dollar is aided by an interest rate increase, is ruled out.
If we assume that the rates are to be hiked to shore up the currency, it would essentially imply that monetary policy independence has been compromised. That perhaps explains the RBI recent clarification.
Besides, global factors may loom less than at present — there is the possibility of global inflation cooling off from current highs due to the renewed conditions of a global slump, as well as an easing of the Ukraine war-related supply constraints.
Therefore, the space is emerging for monetary policy to respond to the domestic situation.
We, therefore, turn to domestic growth and inflation rates, especially the Consumer Price Index, which forms the basis for the mandate of inflation targeting given to the MPC. The first quarter’s growth at 13.5 per cent has been lower than most estimates, most noticeably that of the RBI, which had assumed a quarterly growth of 16.2 per cent.
Based on the lower-than-estimated quarterly growth, the annual projections have also been revised downwards to below 7 per cent by most agencies. This is not a welcome development at a time when we are trying to expand our way out of the Covid-induced vortex of low growth for two years.
Inflation, on the other hand, has moderated from the peak of April 2022 though it is acknowledged that it is still above the upper-end of the tolerance limit of 6 per cent. But there are very few items in the CPI index which can respond to rate action, particularly those in the food basket. The prices of the items under the five major group heads in the CPI are supply-based.
The only rationale for a further rate hike can be to tame/anchor “inflation expectations”. But how many of the agents dealing in these five groups of the CPI, both on the demand and the supply side, pay heed to the MPC’s rate action is a moot point.
Even as the general expectation is that of a rate hike this month-end, there are many good reasons why a contrarian pause would be more in order this time, given our unique growth-inflation dynamics and the largely informal nature of our economy where a rate hike can hurt more than it can help.
The RBI’s own forecast for growth in the current and the last two quarters is 4-5 per cent. With the kind of growth numbers that we have seen for the June quarter (where the actual rate was 20 per cent lower than RBI’s estimates), a rate hike at this juncture can stifle recovery and future growth momentum.
If, as already stated by the RBI, the external sector is not the reason for our rate action, domestic growth impulses will receive a boost on account of a pause, especially when the overall market expectation is that the MPC will either front-load or increase rates sequentially.
The global economy is forecast to grow at a slower pace with the US, Europe and China entering a phase of slowdown. China’s growth at the end of June was just 0.4 per cent and the People’s Bank of China has in fact cut interest rates. India is not an island. Now is the time to support growth through a concerted action by the monetary and fiscal authorities.
A slowdown in the major economies has cooled fuel prices. They are lower than what was assumed in the April 8 MPC statement of “crude oil (Indian basket) at $ 100 per barrel during 2022-23”. For August and September consecutively, the Petroleum Planning and Analysis Cell (PPAC) of the government has posted figures of $97.40 and $92.87, respectively, for the Indian basket — with the latest available figure, as on September 8, being $88. This can be expected to have a moderating influence on retail inflation.
Along with the rate hikes, there has been a reduction in systemic liquidity. From a high of about ₹5-lakh crore, systemic liquidity is now in the region of ₹80,000 crore. The intended tightening of “accommodation” has already taken place. Though liquidity and rate hikes can be said to work in silos, currently there is a double squeeze in operation — liquidity tightness and higher rates.
A further hike now will be equivalent to an indirect tax. The government’s borrowing cost will go up. Already, more than 40 per cent of government revenues go towards interest servicing. Whether or not rate increases help in moderating ‘expectations’ elsewhere, they will definitely result in higher cost of borrowing for the government. The bond market response on the day of the May MPC announcement is illustrative. Just because of a repo rate increase, yields soared on a single day. Obviously, there was no other demand-supply factor at work on that day.
From the government’s side, Finance Minister Nirmala Sitharaman has unequivocally pitched for growth, under-emphasising inflation concerns. In a recent speech, she rightly said that jobs, equitable wealth distribution and making sure India is moving on the path of growth are priorities.
The RBI Governor makes apt quotes from Mahatma Gandhi to enliven his MPC statements and provide a human touch to an arcane subject.
Here is one that he may well try to incorporate as the MPC meets this month-end — “It’s easy to stand in the crowd but it takes courage to stand alone.” One hopes that the North Block-Mint Street duo think and act in concert as they have been doing in the recent past.
The writer is a commentator on banking and finance