As widely expected, the Monetary Policy Committee (MPC) raised the policy repo rate by 35 basis points to 6.25 per cent at the conclusion of its last bi-monthly meeting in 2022 on December 7. This decision was not unanimous. There was one dissent vote. The MPC kept the stance of the policy unchanged at ‘focused on withdrawal of accommodation’ by a 5-2 majority.

In the lead up to this meeting, a broad consensus among market analysts was seen as emerging on the future path of the current cycle of monetary tightening: One, the pace of rate hike will be slower. Two, the peak policy rate will most likely be in the range of 6.50-6.75 per cent. Three, the peak rate will likely be reached by the end of the current fiscal.

Although the policy rate announcement was on anticipated lines, the market rightly found the tone of the statement a little hawkish. Both the equity and the government security prices fell a bit, as a result. The yield on 10-year G-Sec rose by about 7 basis points to 7.30 per cent.

The MPC lowered the growth forecast for the current fiscal to 6.8 per cent from 7 per cent. As a consequence, the growth numbers of the last two quarters of 2022-23 would be lower at 4.4 per cent and 4.2 per cent, respectively. However, there is a fair chance of the growth forecast for 2022-23 being restored to 7 per cent in the next meeting of the MPC, as the growth impulses in the economy have remained strong despite policy tightening so far and the economy’s increased resilience against external headwinds and a structurally stronger external sector. Although it is still early in the day to come to any firm conclusion in this regard, if the country grows 6-7 per cent in the next fiscal, then it wouldn’t be a case of hard lending for the economy.

CPI inflation is projected at 6.7 per cent in 2022-23, with the headline numbers for the last two quarters at 6.6 per cent and 5.9 per cent, respectively. The fact that CPI inflation has remained stubbornly above the upper limit of the target band of 4+/- 2 per cent in 2022, tarnishing the performance record of the newly-constituted MPC, is likely to influence both the approach and the manner in which monetary policy is conducted in the months and years to come.

Both the statements of the MPC and the Governor portray a kind of resolve to fight a decisive battle against inflation not seen before. MPC is of the view that further calibrated monetary policy action is needed to keep inflation expectations anchored, break core inflation persistence and contain second-round effects. This is a tacit but welcome recognition that inflation expectations have indeed become somewhat unhinged and there are visible second-round effects. There is anecdotal evidence to suggest that the inflation faced by both rural and urban lower income groups is much higher than what the headline numbers would suggest. The RBI would do well to conduct some research on this aspect.

For quite some time now, there has been a feeling in the market, and some ambiguity in the policy statements, that the target being aimed for lowering inflation was 6 per cent, i.e., the upper point of the 4+/- 2 per cent band. This likely caused inflation expectations to get unhinged to some degree. However, this time, the air has been cleared with the unambiguous assertion that the target was indeed 4 per cent and the admission that the CPI inflation was likely to remain above 4 per cent for quite some time.

To achieve this, the real interest rate, both at the short as well as the long end of the yield curve, needs to be moderately positive. However, there is no magic solution for bringing down inflation that has strayed higher than the target for a quite a while in a big way.

Development initiatives

As regards the developmental and regulatory policy announcements, the decision to enhance UPI processing mandates from the current single-block-and-single-debit to single-block-and-multiple-debits is a significant step. It will further popularise and entrench the UPI in the retail payment space, the reform and modernisation of which has been one of the country’s success stories in recent years.

However, the permission to extend the dispensation of higher Held-to-Maturity (HTM) limit in respect of the holding of SLR-eligible securities by banks at 23 per cent of their respective net demand and time liabilities (NDTL) by one year i.e., up to end-March, 2024 is not in the interest of promoting better risk management in banks. For one thing, it will only prolong and legitimise the undue regulatory support that the banks have been receiving from time to time to avert mark-to-market losses on their portfolio of government securities, particularly during rising monetary policy cycles, such as the current one.

For another, it will impede better and professional management of interest rate risk on the banking book of banks, as there will hardly be any incentive to maintain any sizeable available-for-sale portfolio which is required to be market-to-market periodically. There is some logic to allow SLR holding under HTM up to the statutory limit, which is currently 18 per cent. To extend it to 23 per cent defies logic. To be sure. risk does not go away if a security is sequestered under HTM. Net interest income (NII) of HTM securities will likely fall if the interest rate further rises.

As the MPC gets down to its task of bringing down CPI inflation closer to its target of 4 per cent, several reforms will be needed to ensure that the medium-term growth trajectory of the economy as also the welfare of society’s vulnerable sections are not adversely impacted. As a recent World Bank report noted, ‘Policy reforms and prudent regulatory measures have also played a key role in developing resilience in the (Indian) economy’. However, a different suite of reforms is needed to deal with the challenges of de-globalisation, food and energy security and climate change.

The beneficial impact on inflation that was felt globally since the early 2000s with China joining the mainstream of international trade and becoming a member of the WTO in 2001, is now on the wane. India needs to take on board such realities and craft its medium term fiscal and monetary strategies.

The writer is a former central banker and a consultant to the IMF. Through The Billion Press

This is a tacit but welcome recognition that inflation expectations have indeed become somewhat unhinged and there are visible second-round effects.