RBI likely to shift focus towards growth slowdown in 2023, says HSBC Securities’ economist

The Reserve Bank of India’s (RBI) rate-setting panel’s tables are likely to turn in 2023, with the focus shifting from inflation towards growth concerns, Pranjul Bhandari, chief economist at HSBC Securities and Capital Markets (India), told Moneycontrol.

“We are forecasting inflation to drop in FY24, compared to FY23, with food inflation being the biggest driver of the fall. Inflation will definitely come under 6 percent in FY24, but it will not go towards 4 percent. It will probably be around the 5.5 percent mark,” Bhandari said in an exclusive interview.

“Then the RBI can take a pause from its monetary policy tightening and give growth a chance. I think the tables will turn in 2023; from inflation concerns, we will move more towards growth concerns.”

The Monetary Policy Committee (MPC), which is the rate-setting panel, is currently striving to combat inflationary pressures in the economy, largely triggered by supply pressures emanating from the Russia-Ukraine war.

Inflation has been consistently above the MPC’s 2-6 percent target band for three consecutive quarters. This is the definition of failure under the flexible inflation targeting framework.

Headline retail inflation measured by Consumer Price Index (CPI) rose to 7.41 percent in September from 7 percent in August. With September’s print, inflation has now completed three full years above the central bank’s medium-term target of 4 percent. For FY23, the RBI forecasts inflation to average 6.7 percent.

According to Bhandari, September’s inflation may not be the peak, given that a lot of global and domestic factors are at play. Domestically, India is seeing weather-related shocks because of climate changes that could drive food inflation higher. In the second half of FY23, or during October-March, Bhandari expects inflation to remain elevated above 7 percent. By March, it could fall closer to 6.5 percent, and then towards 5.75 percent in April-June 2023, she said.

Also read: September CPI at 7.41% | MPC likely to hike repo rate by at least 35 bps in December

Growth to take centre stage

The MPC, in its quest to bring down inflation, has hiked the repo rate – the rate at which the RBI lends funds to banks – by 190 basis points since May. One bps equals one hundredth of a percentage point. The repo rate currently stands at 5.9 percent and economists expect the MPC to hike it further up to 6.5 percent by March 2023.

However, the minutes of the panel’s latest meeting, released on October 14, showed a split emerging within the MPC.

Jayanth Varma, an external member, has said that it is dangerous to push the policy rate well above the neutral rate in an environment where the growth outlook is very fragile.

HSBC Securities’ Bhandari said that India’s gross domestic product (GDP) growth is likely to soften in the second half of the year, especially once the festive season is over.

“Going into Diwali, there's a lot of excitement. But once Diwali is behind, there's no other big thing to look forward to,” Bhandari said. “That’s when you start really noticing all the sort of slowdown indications you're getting. We expect GDP growth of 6.8 percent for FY23 and 5.7 percent for FY24.”

Bhandari’s expectations trail the RBI’s growth forecast for FY23. The RBI estimates India’s GDP to grow at 7 percent in FY23 and 7.2 percent in April-June 2023.

To tackle growth concerns, the MPC, according to Bhandari, will take a pause in hiking rates eventually.

“We have already done a lot of policy tightening. I think there's a place for one more rate hike; perhaps not beyond that,” she said. “I am saying this with some confidence because some of the job will be done through tight liquidity.”

She expects a 50 bps repo rate hike in the December policy, which will take it to 6.4 percent. This will put the 50 bps rate hike cycle of the RBI to an end, she added.

Also read: Monetary policy and failure: A short discussion on what lies ahead of RBI

Tackling policy conundrum

The RBI’s policy conundrum currently goes beyond just growth-inflation dynamics. The RBI has to also deal with a depreciating rupee and a higher current account deficit (CAD) amidst an aggressive rate hike cycle by the US Federal Reserve. India's CAD widened to $23.9 billion, or 2.8 percent of the GDP in April-June, according to the RBI.

According to Bhandari, interest rate hikes and a weak rupee gives a “really good chance” of narrowing the CAD.

“What interest rate hikes and rupee weakness do is that they give exports a chance; it makes exports competitive. So, growth does not fall very much, but it lowers your import. That's the ideal combination,” she said.

At the same time, if liquidity in the banking system is tight, that will also help in inflation control, she said. India’s banking system liquidity briefly slipped into deficit towards September-end amidst tax outflows and aggressive dollar sales by the RBI to counter the rupee’s weakness. RBI Governor Shaktikanta Das has said that the central bank will continue to take liquidity operations on both sides.

In order to infuse liquidity and avoid extreme situations, the RBI can conduct variable rate repo auctions under which it lends short-term money to the markets temporarily, Bhandari said. However, liquidity will be slightly on the tighter side, going forward, she said, adding that it is the right policy to have currently in the backdrop of monetary policy tightening.