On August 5, the Reserve Bank of India (RBI)’s monetary policy committee (MPC) unanimously raised the policy repo rate by 50 bps to 5.4 percent, taking it back to its pre-pandemic level. The rationale cited for this action was uncomfortably high CPI inflation (and its level above the upper threshold limit of the target), and rising threat of imported inflation due to increased volatility in global financial markets.
While majority of the economists and market participants were expecting the MPC to raise the repo rate in the August meeting, there was a debate on the actual magnitude of increase. People who expected a relatively modest increase of 25 to 30 bps in the repo rate felt that today’s inflation was caused more by geopolitical tensions and supply chain disruptions rather than sustained demand-pull pressures.
Also, the MPC does not appear to be overly confident about the growth outlook. While defining the outlook, it has cautioned about several headwinds including the risk of global recession. Despite frontloading the interest rate hikes (140 bps between May-August), it has not changed the stance of monetary policy from ‘accommodative’ to ‘neutral’, but reiterated that it would remain focused on ‘withdrawal of accommodation’, to control inflation, while supporting growth. The only member who has not supported this ‘stance’ is JR Varma.
A large portion of the RBI Governor’s speech before making the policy announcement was dedicated to explain the growing external vulnerabilities due to globalised inflationary surges, tightening of financial conditions, sharp appreciation of the US dollar, etc. He emphasised that India has witnessed large portfolio outflows of the order of $13.3 billion during FY23 so far, and the rupee has depreciated by 4.7 percent against the US dollar. While he offered comfort on the size of the foreign exchange reserves ($572 billion on July 22), it is public knowledge that India’s forex reserves declined by $29 billion between the last policy and now.
In our opinion, the magnitude of today’s repo rate increase was primarily influenced by the pressure created by the global central banks’ aggressive policy tightening in the past few weeks, and the considerations of India’s external sector stability. Since mid-July, at least eight major central banks including the US Federal Reserve, the European Central Bank, and the Bank of England have raised their policy rates between 50 to 80 bps, which analysts describe as a ‘reverse currency war’ between monetary policymakers.
According to Financial Times, in the three months to June, 62 policy rate increases of at least 50 bps were made by the 55 central banks tracked by it. Another 24 big increases of 50 bps or more have been made in July and August so far (including the yesterday’s 50 bps increase by the Bank of England), marking the biggest number of large rate moves at any time since the turn of the millennium. As described by the head of foreign exchange strategy at Rabobank, “We have seen this pivot point in the market where 50 is the new 25”.
Even as the choice of ‘50 bps’ (instead of 25 bps) is influenced more by the global central banks’ actions, the MPC’s ‘rate increase’ decision is certainly facilitated by India’s steadily improving growth outlook, and a pick-up in credit extended by commercial banks and non-bank finance companies (NBFCs). According to the MPC, domestic economic activity is exhibiting signs of broadening. Capacity utilisation rate in India’s manufacturing sector in Q4, FY22 was at 75.3 percent relative to its long-term average of 73.7 percent. Bank credit growth has accelerated to 14 percent (y-o-y) as on July 15. Incoming data of corporates for Q1, FY23 reflected buoyancy in the sales and profitability of companies.
While market participants have started debating about the future action plans of the RBI, the Governor has clarified that it won’t be possible to give future guidance on the rate action. The RBI is still not seeing strong ‘demand-pull’ pressures in current inflation trends, and feels that inflation is more due to supply-side issues and global events. That is precisely the reason why the RBI wants to withdraw liquidity in a gradual fashion.
Recently, when the banking system witnessed sudden contraction of liquidity due to the tax outflows and the RBI’s forex interventions, the RBI promptly conducted a variable rate repo auction of Rs 500 billion of three days maturity. Even in the August 5 policy statement, the RBI has assured that it will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as per the system’s liquidity requirement.
Going ahead also, the monetary policy moves of the emerging market central banks including that of India will be directly and majorly influenced by the actions of big global central banks, and their broader impact on global economic conditions.Rupa Rege Nitsure is Group Chief Economist, L&T Financial Services. Views are personal, and do not represent the stand of this publication.