MC Interview: Rupee likely to be less volatile next fiscal, says Crisil economist Dipti Deshpande

What is the outlook on the 10-year government bond yield for the year-end 2022 and March 2023?

Yields are likely to remain range-bound towards the end of 2022, driven by concerns of a global slowdown and aided by the recent moderation in crude oil prices. But risks from volatile financial market conditions, high government borrowings and elevated inflation remain.

The Fed policy rate is expected to peak only in April-June 2023 at 5-5.25 percent, according to S&P Global. That could maintain some pressure on yields. Due to this, we expect the benchmark 10-year G-Sec yield to average 7.5 percent in March 2023.

Will the Reserve Bank of India focus on liquidity management in the coming months as liquidity has improved on capital flows coming back?

The RBI is likely to maintain a proactive approach towards liquidity management, intervening in transient periods of deficit, while not letting the system gravitate towards surplus liquidity conditions seen in the past two pandemic years. The objective of the monetary policy stance of ‘withdrawal of accommodation’ is to facilitate effective monetary policy transmission (as surplus liquidity conditions hinder transmission during tightening).

With moderation in currency in circulation after the festive season, a likely increase in government expenditure in the last quarter of the fiscal, and the return of foreign portfolio inflows, liquidity conditions are expected to improve. The RBI will prefer to tread on the side of caution and not strain the system for liquidity as it wants to support growth with an eye out for possible signs of inflationary pressures.

Why do you think the policy was hawkish?

The RBI’s slowing pace of rate hikes was on expected lines as the upside risks to inflation are likely to reduce over the next couple of months. Yet the governor preferred to sound cautious because core inflation continues to be sticky. Then there are the risks to the medium-term inflation outlook from geopolitical tensions and financial market volatility, which could put pressure on prices and the rupee. Weather-related disruptions are also a possibility. So the tone was par for the course. We expect the RBI to maintain sharp focus on controlling inflation expectations and reducing their second-round effect on prices.

How many more rate hikes can we expect?

Between now and the next policy (scheduled for February 6-8, 2023), the RBI will closely monitor the impact of its previous rate hikes on domestic demand and core inflation. Monetary policy works with a lag of around three quarters. The rate hikes so far are yet to be fully transmitted to bank deposit rates and loan rates. We expect the transmission to the broader economy by next fiscal, which could weigh on domestic demand and, possibly, core inflation.

The RBI will also consider the actions of the US Federal Reserve, which is a key mover of global financial conditions. The Fed is also considering slower pace of rate hikes, which could imply lower spill-over risks to the rupee and domestic financial conditions. The RBI has kept its options open on the future course of the monetary policy; hence, future rate hikes cannot be ruled out if risks to inflation rise.