The Reserve Bank of India’s monetary policy resolution of April 2023 surprised everyone when it signalled a pause in its rate hikes, even as inflation was edging up from 5.7 percent in December 2022 to 6.4 percent in February 2023. Retail inflation actually declined to 5.6 percent by March 2023, but the data came in much later. Perhaps at that point, the RBI was more worried about sluggish GDP (estimated at 7 percent for 2022-23 and 6.5 percent for 2023-24). By keeping policy rates unchanged and focusing on withdrawing accommodation, it was signalling a balanced approach to growth and inflation.
The economic backdrop to the June MPC is not very different as far as the inflation, growth and liquidity fronts are concerned, but some developments are worth noting.
Respite on Inflation
The consumer price index (CPI) inflation dropped further from 5.6 percent in March 2023 to 4.7 percent in April 2023, tantalisingly close to the RBI’s stated target of 4 percent. This was largely due to a decline in food prices as also fuel prices, helped by a host of factors such as improved rabi crop, cuts in excise duty on petrol and diesel, and reduction in import duties on key raw materials and crude edible oils. The 250-basis point policy rate cut of the previous financial year must also have worked its way through the system
Oil prices continue to be a key determinant of inflation. Though average imported crude price had declined from September 2022 thanks to cheaper imports from Russia, the discounts have now started thinning and the surprise cuts announced by the Organisation of the Petroleum Exporting Countries (OPEC) in April 2023 could cause oil prices to rise again. Another key worry is on the supply side with the prospects of a normal monsoon still being stated to be only 50:50, with the added threat of El Nino, although not crystalised at this point. However, the continued decline in retail inflation — from 6.5 percent in January to 4.7 percent in April 2023 — will be cause for cheer and may perhaps turn the RBI’s attention back to growth again. That means the rate pause is likely to continue, though the RBI had clarified it was limited only to the previous meeting.
Worries About Growth
The RBI’s estimate of over 7 percent GDP growth for 2022-23 is in line with the second advance estimate of the National Statistical Office, though revisions in numbers between releases, especially in trade deficit, can spring surprises. While foreign trade itself is a small proportion of GDP, deficits can swing GDP either way owing to the fact that these are always deducted from GDP. Thus, a large decrease in deficit (owing to falling oil prices) can boost GDP and vice-versa. India’s oil bill started falling from September 2022 with cheaper Russian imports but looks to be rising again. The RBI’s inflation and growth forecasts are based on the assumption of oil price at $85 a barrel, which could be tested. If oil prices keep rising and exports continue to be sluggish, the lower GDP growth forecast of 6.5 percent for 2023-24 may also be at risk. In fact, the IMF's estimates are lower at 5.9 percent.
Another worry on the growth front is the continued poor performance of manufacturing on which government relies to generate jobs and absorb surplus labour from agriculture. Despite the push given (Production-linked incentives, tax cuts and low interest rates), it managed a growth of only 0.6 percent in 2022-23 even as overall GDP grew by 7 percent. This is puzzling though the RBI seems convinced that corporate investment activity is on the upswing, on the back of indicators such as purchasing managers’ index, growth in steel and cement and the 15 percent increase in bank credit. But none of these seems to reflect in the sector’s gross value added (GVA) which is what counts for growth.
Bank credit grew by 15 percent between December 31, 2021 and December 30, 2022 but over half of it was under short-term and medium-term working capital credit. Nearly half (47 percent) of all long-term loans were under personal home loans and NBFCs credit, with the industry’s share at a mere 12 percent. In fact, the overall credit to industry grew by only 9 percent, with infrastructure and construction sectors logging only 5 percent and 2 percent growth, respectively. Loans to these two sectors form about 40 percent of all industrial credit. These facts again don’t seem to tie in with the RBI’s hopes of private corporate investment driving growth.
Rs 2,000 note recall and liquidity
The stated policy was the withdrawal of accommodation, but liquidity witnessed ups and downs, initially tightening till around March 2023 and later easing up as the government began to spend. A major development on this front was the sudden decision in May 2023 to withdraw the Rs 2,000 notes. Though everyone seems to agree on its economic impact being marginal, opinion varies on its liquidity impact, from being neutral (as one denomination gets exchanged for others) to being positive (higher inflows into banks, bringing down short-term rates). But it will not be until September 2023 when the full impact will be known.
Overall, the rate hike pause is likely to stay, which will be pro-growth, but how oil prices and supply side factors play out on inflation will continue to be the key to the RBI’s moves on liquidity and rate management.
SA Raghu is a columnist who writes on economics, banking and finance. Views are personal, and do not represent the stand of this publication.
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