After Wednesday’s 50 basis points hike in the repo rate, the Reserve Bank of India still have 75 bps to go, Shubhada Rao, founder of independent research firm QuantEco Research Ltd. told Moneycontrol in an interview. Rao pointed out that the RBI has raised its inflation forecast by a massive 100 bps, which shows that the central bank has anticipated every possible adverse effect. While the cash reserve ratio was untouched, it is still on the table to be used, she said. Edited excerpts from the interview:
What is your quick takeaway from the policy today?
The market was expecting somewhere between 35-50 bps, so the repo rate hike was not a surprising. The bigger point is that inflation forecast has been hiked by 100 bps to 6.7%. This is substantial and with this revision, I would believe that the RBI is pricing in a lot of adverse effects on price stability. That begs the question as to how much more in terms of rate hikes can we expect now. My sense is that between now and December, RBI would affect another 75 bps hike in the repo rate. It could be either 25 bps multiples or could be even front loaded, say 40 bps followed by smaller hikes. After December, we reckon that there could be a pause. So by December, the repo rate would be 5.65 percent but that may still not be the terminal repo rate.
Why do you foresee a pause after December when you don’t expect the repo rate to be terminal?
My assessment it that in February policy, the RBI could take a pause to assess if the government’s fiscal position is changing. The new fiscal year budget would be out and the fiscal position for FY23 would be known. The RBI would want to assess how the government’s fiscal position for the next year would be. It could resume its rate hiking cycle in April.
Is there a possibility of out-of-turn policy measures?
An out of turn CRR (cash reserve ratio) hike may not be warranted. One is RBI is leaving room for forex intervention. For instance if there is a $5 billion forex intervention, the resulting liquidity drain would tantamount to a 25 bps CRR hike. Also, the forex reserves are around $601 billion. So the RBI seems to be keeping ammunition for intervention. Forex intervention and normal currency leakages will take care of liquidity to some extent. We believe that CRR would be on the table to be hiked, but won’t be out-of-turn.
Even an out-of-turn repo rate hike may not be needed. As such, we are looking at 7.5% average CPI inflation for the first half of FY23. Unless oil prices rush higher to say $130-140 per barrel or we see a highly irregular monsoon, and services inflation momentum accelerates from the current levels, then we could see a case for emergency rate hike.
The RBI has sounded more positive on growth and investment this time. Do you share the optimism?
There doesn’t seem to be a very huge negative risk for the 7.2% percent projection at this point in time. We are seeing PMIs doing better, we are seeing consumer confidence doing better and business sentiment is better. So long as demand conditions are getting better, business confidence may not correct lower. In this scenario, if inflation doesn’t go beyond 7%, then the RBI can afford to review and take a call on the next rate hike.
Yes, the RBI was sounding fairly optimistic on rural consumption also this time. More importantly, the terms of trade is coming in favor of rural. Through some indirect measures of rural co-operative banks being given some enhancement for housing, they are looking at beyond agriculture to raise the growth multiplier for rural. Let us not forget that government could raise MSPs too. This could be a double digit hike because input prices have gone up substantially and farmers need to be compensated.
I would think that in terms of private final consumption, the RBI is baking in a better number. Net exports is something we will have to put last in terms of growth enablers. For GDP, gross fixed capital formation may offset the net exports dampner on GDP drivers.
Where does external sector fit into this?
External sector risks have risen. But a current account deficit of up to 3.5% of GDP should not be a bother. Recall that during taper tantrums, it had gone to above 5% which was a worry and we had inadequate forex reserves at that time. This time around it doesn’t look destabilizing. Surely, CAD would be a point of worry particularly from the perspective of capital flows. The rupee will depreciate but not in a knee jerk fashion. A 3.0-3.5% CAD is manageable at the current juncture. But we need to keep track of imports, especially oil imports. On petroleum, there is an offset of exports here. It will get significant which is a salutary factor on trade balance. We should also remember that at 7.2% GDP growth, our import intensity is not significant and so the pressure on external balance is less.
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