In a week when central banks spooked the global markets, India’s very own Shaktikanta Das, Governor, Reserve Bank of India, handled out a wave a calmness. The Sensex rose over 1,000 points or 1.8 per cent on Friday, in stark contrast to commentaries from the chiefs of Federal Reserve and Bank of England, which sent ripples across the globe.
Interestingly, as much as Das boosted confidence, Michael Patra, Deputy Governor, also made a powerful statement when asked about gradual withdrawal of accommodative stance. “Soft landing is for advanced economies. For India, it’s a take-off.”
In fact, the commentary from the RBI on September 30 was a lot more reassuring and echoed more positiveness, compared to August 5. This is despite increasing the base repo rate to 5.9 per cent, up 190 basis points (bps) since March 4, inflation stubbornly staying put at seven per cent, and global macro turning more uncertain in recent weeks.
What’s driving the confidence and what can spook the show?
Strong domestic support
After three hikes till August, the domestic consumption story of India remained intact. A proof of this is the recent credit off-take data, which posted 16 per cent year-on-year growth. Sustained revival in urban consumption, rural demand gaining momentum, overall business confidence at a 51-month high, strong show by the services sector, and robust tax collections are keeping the economy and the overall momentum in good stead.
Inflation, which remains largely imports led, is persistently high. But the MPC doesn’t seem to be considering it an unknown variable like it did about 6-8 months ago.
To that extent the 50 bps hike seems more an answer to what central banks globally are doing and not be left behind the curve. In other words, should India be vulnerable to second-order effects because of the global shocks, the country shouldn’t be caught unaware, especially on the inflation front, and the rate hike is an adjustment from that perspective.
That said, rate hikes come with a lag effect of 6-8 months, and only by December the real impact of the 190 bps repo rate hikes may be reflected.
This could be the tricky aspect. While the system liquidity measures as liquidity adjustment facility (LAF) has reduced by ₹1.5-lakh crore to ₹2.3-lakh crore in August-September, compared to the June-July level, the position is relatively better compared to what was anticipated by banks. However, unlike the pandemic era, the systemic money may not be adequate to propel growth.
That would have to come from deposits, which the RBI believes have already started gathered pace. The real challenge for banks would be the tightrope walk in terms of profitability.
In June quarter, even as deposit rates didn’t spike much, yield on assets fell by 10-50 bps for the industry. Going forward, their willingness to cede a bit of profitability will play a determining role in their loan growth forecasts. Again, the full impact of this factor will show up by December.
Unlike the US Fed, which is having to tread between rates hikes and ring-fencing the economy from recession, the RBI’s job seems a relatively easier one for now.
But global factors remain a huge uncertainty. While the Fed has indicated another 75 bps hike, will it stop at that? If not, the RBI cannot afford to ignore the rate movement of global central banks, if it shouldn’t be left behind the curve, especially in terms of currency risk management.
This is also important to ensure that inflation doesn’t spiral beyond control. The GDP estimates have been brought down only by a small number — 20 bps to 7 per cent in FY23. While the local demand outstrips supply and the festival season is anticipated to be stronger than the past two years, the current projection hinges on the strong pent-up demand factor playing out. Will the four rounds of rate hike play a spoilsport remains to be seen.