With the 25-bps hike today that takes the repo rate to a seven-year high of 6.5 percent, the Reserve Bank of India has acted in line with market expectations. The moderating retail inflation in the last few months and moderate hikes by the US Federal Reserve have reassured the RBI to go for a 25-bps hike, ending the fiscal year on a much more optimistic note.
Supporting Economic Growth
Importantly, the central bank remains committed to providing adequate liquidity to support economic growth. Key drivers of economic growth of 6.8 percent estimated for this year have been:
* Strong urban consumption
* Improving rural demand
* Agriculture
* Better capacity utilisation
* Uptick in private capex.
Next year’s GDP growth is estimated at 6.4 percent, higher than what economists had predicted. This is on account of continued growth in the above mentioned factors. At a growth rate of 6.4 percent, India will continue to be well-placed amongst most global economies.
Inflation Discomfort
Inflation is estimated to average 6.5 percent this year and is estimated at 5.3 percent for FY-24. This is still above the RBI’s tolerance level of 4 percent. In fact inflation for Q4 of the next fiscal is estimated at 5.6 percent versus inflation of 5.7 percent in Q4 of FY-23. This possibly rules out any rate cut in Q1 next year which many market players were expecting.
Also, while it is broadly believed that we are at the top of the interest rate cycle and there is likely to be a long pause, the Monetary Policy Committee is likely to look at the data points on inflation and growth closely for further action.
CAD Relief
Another relief will be the moderation in Current Account Deficit (CAD) which came in at 3.3 percent of the GDP in Q3, mainly due to lower imports, higher inward remittances and rising service sector exports. But CAD in the upcoming quarters will largely depend on external factors such as commodity prices, global demand and geopolitical tensions.
Global recessionary trends at this stage seem more benign than what was estimated earlier. If so, we could see firmer commodity prices in the second half of next year. This could have an impact on CAD.
Ensuring Liquidity
The other factor which is likely to determine interest rate trajectory is liquidity. The system has moved from high liquidity to just adequate liquidity. Given the strong credit growth there has been demand for liquidity and banks have increased deposit rates progressively.
The MPC continued with the stance of withdrawal of accommodation, but has stated that they will ensure liquidity to support economic growth and that the central bank could operate on both sides.
Having said that, it is equally clear that the policy committee is firm on withdrawal of accommodation given the unforeseen challenges. The stance is likely to move to neutral in the next policy.
We expect the MPC to pause for the time being and watch the data points closely before further action. Global headwinds could impact inflation and growth and thus trigger further action on rates. While we do expect a pause in rate increases, we do not completely rule out rate hikes. If current estimates turn out right, it certainly rules out a rate cut.
Shanti Ekambaram is Whole-time Director, Kotak Mahindra Bank Limited. Views are personal and do not represent the stand of this publication.
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