Monetary policy expected to be an encore status quo with little surprise, says Churchil Bhatt of Kotak Mahindra Life

Monetary policy expected to be an encore status quo with little surprise

By Churchil Bhatt, Executive Vice President & Debt Fund Manager at Kotak Mahindra Life Insurance Company

When India’s monetary policy committee (MPC) members meet in early October, they are likely to have mixed feelings. Domestic developments, since their last meeting, are mostly positive. Sharp fall in vegetable prices and a satisfactory revival of monsoon in September are likely to bring headline consumer price inflation (CPI) back within the MPC’s tolerance band. Additionally, India’s much awaited inclusion in JP Morgan Emerging Market Global Bond Index is set to benefit domestic currency as well as bond markets. Alas, that is not all.

Disruptively volatile global bond yields have begun to impact local bond yields and to some extent even equity markets. This along with rising crude oil prices have the potential to influence the future course of our monetary policy adversely.

In effect, the MPC is faced with Dicken’s world view of being in ‘the best of the times’ and ‘the worst of the times’. Since good domestic macros do not require any immediate policy response, it is the global economic environment that continues to influence domestic policy expectations.

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Churchil Bhatt

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Depending on what data one may opt to look at, global economy is simultaneously avoiding and approaching a recession at the same time. Until recently, global bond markets were rather convinced that the world economy will see a sharp slowdown, if not a recession. Over last month or so, they gave up on this possibility of an imminent recession. As a result, bond yields in most major economies have gone through the roof. Yet, the jury is out on the nature of ‘economic landing’. But regrettably, bond markets, unlike real economies, cannot afford the luxury of patience.

To be fair to markets, they are not alone in this muddle. This incoherence is evident in actions of developed market policy makers as well. In a world of hurried rate hikes, the pace of ‘quantitative tightening’ (QT) has been rather leisurely. In most major economies, financial conditions seem sufficiently tight when one looks at price of the money (policy rates), yet adequately loose if one looks at the size of money available in their financial system.

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The unhurried pace of QT is adding to the odds of a ‘soft landing’, thereby bolstering the ‘higher for longer’ rates narrative. In our view, further progress on QT is a necessary condition to quell the stubborn global inflation we face today. Unless faced with a ‘hard landing’, major central banks should continue with measured QT, even as they consider pausing on policy rates.

Domestically, headline CPI for the rest of FY23 is likely to average around 5 percent, while GDP for the same period is expected to be ~6 percent. Our forex reserves remain healthy and domestic currency is stable. Local bond markets remain well behaved in spite of a large government borrowing program. Overall, Indian economy is doing well on most macro-economic parameters.

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In short, our domestic conditions do not warrant any further policy response. Hence, this policy is expected to be an encore status quo with little surprise. Stance of the monetary policy, if it still has any significance, will likely be untouched in light of rising crude prices and global ‘soft landing’ backdrop. With festival season on the horizon, banking system liquidity is likely to remain comfortably within +/-1% of NDTL (net demand and time liabilities), thereby eliminating the need for any liquidity adjustment.

Going forward, global Central Banks will continue to align their policy actions with their own economic circumstances. And the MPC cannot insulate its decisions completely from their actions. More likely than not, the MPC will not feel the need to consider a meaningful departure in its policy response from global peers. Hence, MPC’s opportunity to ease domestic policy will be proportionate to the severity of economic landing in major economies. But, that is a story for another day.

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