Interview| RBI may hike repo rate by 50 bps this calendar year; FY23 inflation forecast has upside risks, says BoB Chief Economist Madan Sabnavis

What is your assessment of the MPC’s latest minutes?

I think the MPC has made it quite clear that it is cognisant of the fact that inflation has been rising and that there are a lot of uncertainties in the global economy. This is something that is going to impinge on inflation, going ahead, and therefore there is an indication that the easy liquidity conditions, easy money and lower interest rate regime will probably be coming to an end. Traditionally, the MPC has to target inflation. However, we saw that an exception was made in the last couple of years consciously because it was felt that until growth becomes stable or durable, the RBI or the MPC would continue to look at growth rather than inflation. Now, quite clearly, the MPC recognises that inflation appears to be a bigger threat and, going forward, it will be closely monitored when it comes to taking a decision on the future course of action.

How do you read the RBI’s inflation forecast for FY23, given that the impact of fuel price hikes has not been completely factored into the March print?

I think the RBI’s expectations of inflation appear to be in line with what we had projected for this fiscal year. And even if we go by the quarterly projections, there could be an upside to those because almost on a daily basis, there are new developments, both on the domestic and global front, which were not known earlier. We have seen that the price of crude oil has suddenly become a bit more stable. We are no longer talking of crude oil prices being at $120 or $140 per barrel; it could be somewhere around $110. At the same time, there is a lot of upheaval in the edible oils market. Hence, the pressure points on inflation, both positive and negative, seem to be fairly volatile now. So, I would think that whatever inflation forecasts have been made by the RBI would definitely have an upward bias rather than a downward bias.

How clear do you think the RBI is in terms of demand-driven and supply-driven inflation when it derives its forecast?

We should remember that both the factors work together. When international prices go up, for India, being a large importer of oil, a supply side shock comes in. However, the supply side shock will not be that serious in case demand is not that aggressive. Hence, when we look at inflation, it is a combination of both factors.

What are your forecasts for inflation?

For the first quarter (April-June), we could be looking at inflation in the region of about 6 percent. Here, we should remember that there will be a statistical advantage because of the base effects leading to relatively lower inflation numbers. The general level of prices is going to remain very high in the coming quarter. For this financial year, we expect inflation to be somewhere between 5.5-to- 6 percent, almost in line with what the RBI has projected. However, there could be an upward bias to our forecast because we have assumed that crude oil will be around $100 per barrel. We do not know whether crude oil prices will go down.

Could you elaborate a bit?

What we are more concerned about is inflation of manufactured products. We had seen that in the third quarter of the last fiscal year, there was a tendency by a number of producers to increase final prices because of higher input costs, which were absorbed by them for over a year. So, there's been one round of passing higher input costs to the final cost, which has led to higher manufactured inflation. Now, with the second round of increase in global commodity prices, due to supply-chain disruptions in the oil and edible oil market among others, there could be another pass-through of higher input prices. So, there is a threat of an upside risk to the inflation forecast.

How do you think the RBI will balance the growth-inflation trajectory?

This is always a conundrum for any central bank, because starting probably in February, when the MPC met, it did look like that growth could be higher than the RBI’s projections are now. Now, the RBI has lowered its own expectations of growth for the year and increased the expectations on inflation. It looks like the tilt will be towards managing inflation. The reason being that if inflation is left unchecked and keeps moving higher, there would definitely be an impact on overall consumption to come down and that could become debilitating against growth. Higher inflation definitely has the power and potential to lower consumption. Lower discretionary consumption could come in the way of the revival of the consumption cycle. I think the RBI will balance it.

What is your expectation on the RBI’s policy actions, going forward?

I do not expect any drastic action from the RBI; it will be in a measured and calibrated manner in which the repo rate could be increased by 25 bps starting June, with a change in stance to neutral. This is because the RBI has made the market ready for such an action. The government securities acquisition programme has come to an end, there has been a steady absorption of liquidity through SDF and VRRR. There are indications that the overall liquidity in the system is also being managed; we have also seen dollar-rupee swap auctions. The market is now prepared for the RBI increasing rates and therefore there will not be any kind of a panic reaction.

Government and corporate bond yields are up, and some banks have increased their MCLR because their cost of bulk deposits has gone up. So, if the cost of deposits has gone up, which has been the case for some banks, the MCLR has been increased. So, I think the system is gradually moving towards a higher interest rate regime. However, it will definitely not be a sharp increase; it will be very gradual, and I think that’s more important for the market.

Where do you see the repo rate headed in this cycle?

We are looking at a 50 basis points repo rate hike this calendar year. The RBI will be looking at its own focus of inflation. If it is 6.3 percent in the first quarter, then when the MPC meets in June, it already has high inflation. Therefore that is the right time to intervene. Subsequently, the RBI’s forecasts are more sanguine. They're coming down to 5.8 percent and then it goes down further to 5 percent. Therefore, frontloading of repo rate hikes will be done in the next couple of policies. Assuming that the world turmoil comes to an end or tapers, it may not be necessary for the MPC to increase interest rates further. Decisions will be data driven for sure.

Do you think the RBI will fall a little behind the curve compared to the Fed?

I would totally disagree with this concept of falling behind the curve. We need to define the curve by looking at our own objectives. We do not have to replicate what is happening in the US because they are confronting much higher inflation than what the Fed’s target is. We should remember that for the US, growth is not much of a target. In fact, there is a debate that the Fed raising rates could actually lead to a recession in the US. Compared to that, what the RBI is doing is going to be very calibrated so that we don't run into a situation where aggression shown on the repo rate will hamper growth.

Do you believe that the MPC should drop the word ‘stance’?

In terms of signalling, stance is important. With an accommodative stance, the RBI is signaling to the market that there will not be any rate increases in the near future. When the MPC switches to a neutral stance, it is conveying to the market that it should be prepared for rate hikes. If the RBI chooses not to increase the repo rate in June, I am quite sure that the stance will be changed to neutral so that in the next policy in August, there will be an increase in the repo rate. However, the RBI should also offer some clarity on the meaning of the stance.

Do you think the Standing Deposit Facility (SDF) is going to be an effective tool to absorb liquidity or will the RBI have to do more?

If you want to remove liquidity permanently, you have to do it by selling government securities in the open market. For this, the RBI needs to have government securities to sell to banks. They also have the option of floating MSS bonds. Right now, I think the RBI does not want to permanently take liquidity out because of an expectation that demand for credit will pick up and that the government borrowing plan needs to be supported. So, in that sense, SDF seems to be an appropriate tool.

Where do you see the 10-year bond yield by September and till March?

I think 7.25 percent by September seems to be a given at this stage, and if the repo rate is also being increased by 50 basis points, then I think we could see it headed towards 7.50 percent by March end.

How will the RBI support the bond market?

The RBI is making sure that there is a lot of discipline in the market by giving the right signals. However, the RBI cannot control how the market will behave. There is an uncertainty about whether the government’s fiscal deficit target will actually be met, the record borrowing programme, and statements from the Fed, which are driving bond yields. The market is getting very jittery as it is reacting to every bit of news.

Why do you think there is a disconnect between what economists are thinking and how the RBI is behaving?

I think everybody has their own way of making projections. The RBI normally tends to be a bit conservative as that is a better way for any central bank to determine monetary policy, not take any rash action. Economists, on the other hand, have their own vision about how things are going to behave, and accordingly, overstate or understate.