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RBI policy tone seems more hawkish; expect repo rate hike by 35-50 bps in 2HFY23: Unmesh Kulkarni of Julius Baer India

The rate hike cycle is not over yet, as the MPC is desirous of the CPI inflation getting back into the RBI's comfort zone (below 6 percent) and preferably towards the neutral level of 4 percent.

August 05, 2022 / 05:05 PM IST
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Unmesh Kulkarni – Managing Director Senior Advisor at Julius Baer India

RBI on August 5 raised the policy rates by 50 bps, in line with what we were expecting. The debt markets had become a bit euphoric over the past few days, expecting RBI to hike less (25 bps – 35 bps), especially in the context of the fall in global commodity and crude oil prices. However, RBI has stayed firm on its resolve to tackle the elevated inflation.

The Monetary Policy Committee (MPC) is quite comfortable with the current growth scenario, with the domestic demand showing resilience and signs of broadening, a normal monsoon and adequate kharif sowing, urban demand improving and several economic indicators showing buoyancy, including PMI and capacity utilization. The RBI's assessment of domestic growth, is therefore, better than market perception around global recessionary trends impacting India, and this allows the RBI to use monetary policy tools more decisively.

Besides, the MPC is also acknowledging the persistent high domestic inflation, and CPI remaining above the upper tolerance level (6 percent) of its target range. Although RBI expects CPI to soften during the course of the year, it views inflation as being at uncomfortably / unacceptable high levels. RBI has chosen to ignore the recent softness in oil and commodity prices, and finds significant uncertainty in the near-term inflation trajectory, which is heavily dependent on the global economic and geo-political environment. Household inflation expectations remain elevated, supply chain pressures persist (though having started to ease) and the transmission of high input prices into the manufacturing and services sectors could continue to create inflationary pressures.

Also readMonetary Policy | RBI’s move to ensure a safe and soft landing

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The tone of the policy was more hawkish than what markets were expecting ahead of the announcement. In fact, a key aspect that the RBI Governor stressed upon, during the course of his speech, was the external sector and the pressure on the Indian rupee and forex reserves. It is quite apparent that, besides fighting inflation, the stability of the INR has also been a determinant of the MPC decision to hike 50 bps, in the backdrop of a strong US Dollar, capital outflows and the drop in India’s forex reserves over the past few weeks.

On the liquidity front, RBI is quite satisfied with the ongoing normalization of liquidity (from Rs 6.7 trillion in April/May to Rs 3.8 trillion in June/July). The MPC has chosen to continue on the path of "withdrawal of accommodation", although it was widely expected that the stance would formally change now to “neutral” or “calibrated tightening”. However, the wording of the policy stance is currently not very relevant, as RBI is already on a path of aggressive tightening and front-loading the rate hikes.

Also readRBI Policy | Another 50 basis point hike done, so what's next?

The rate hike cycle is not over yet, as the MPC is desirous of the CPI inflation getting back into the RBI's comfort zone (below 6 percent) and preferably towards the neutral level of 4 percent. Another couple of rate hikes, therefore, cannot be ruled out, in the second half of FY23, although RBI may want to slow down the pace a bit. We expect another 35 bps – 50 bps hike in 2HFY23, spread across a couple of policy meetings, as RBI continues to persevere with the “withdrawal of accommodation” and ensuring stability of the Rupee.

The fixed income markets, which had become bullish recently, are likely to settle down to more realistic levels, as they grasp the hawkish undertone of the policy. At this point in time, RBI is clearly focused on fighting the unacceptable high inflation trajectory and containing inflationary expectations, while also ensuring stability of the INR. RBI's policy actions also need to be viewed in context of the stance of other global central banks, which are also on a path of aggressive tightening to fight the extraordinarily high inflation in their respective economies.

The 10-year g-sec benchmark yield, which had eased all the way to sub-7.15 percent levels ahead of the policy announcement, is likely to retrace over the next few weeks to 7.35-7.50 percent levels, assuming oil prices remain rangebound. The g-sec supply through weekly auctions, and its absorption by the markets, needs to be monitored closely, as the RBI is not yet stepping in to support through open market operations.

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Unmesh Kulkarni is the Managing Director - Senior Advisor at Julius Baer India.
first published: Aug 5, 2022 05:05 pm
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