MPC | Immediate pausing is off the table

Reserve Bank of India Governor Shaktikanta Das (File image: PTI)

A hike in the policy repo rate of 35 bps to 6.25 percent and retention of the stance at ‘withdrawal of accommodation’ in in December 7 monetary policy indicate that majority of the monetary policy committee (MPC) members see inadequate progress in the Reserve Bank of India (RBI)’s fight against inflation so far.

According to the MPC statement, headline inflation is expected to remain above or close to the upper threshold in both Q3 and Q4 of FY23. In fact, the MPC has increased its inflation projections for these quarters by 10 bps each in today’s policy (to 6.6 percent for Q3 and 5.9 percent for Q4), citing the persistence of core inflation and increasing trends in the prices of cereals and spices. However, it has retained its inflation estimate for Q1, FY24 at 5 percent, most likely by factoring in the lagged impact of the past concentrated increases in the policy rate. At the same time, the MPC is not much sanguine about the growth outlook on account of the lingering geopolitical tensions, tightening global financial conditions and trade slowdown. It has lowered its GDP projections for both Q3 and Q4 of FY23 by 20 bps each (to 4.4 percent for Q3 and 4.2 percent for Q4). Furthermore, it has revised downwards its GDP estimate for Q1, FY24 from 7.2 percent to 7.1 percent.

Interestingly, the December 7 policy moves are not endorsed unanimously by the MPC members. Consistent with his stance at the time of the last policy review, JR Varma (an external member) voted against both the rate and policy stance decisions. As per the minutes of the last monetary policy, Varma had found it dangerous to push the policy rate well above the neutral rate in an environment where the growth outlook is very fragile.

Ashima Goyal, another external member, too voted against the policy stance of ‘withdrawal of accommodation’ on December 7. As per her views expressed in the last policy minutes, “high uncertainty calls for slow steps. If demand slows anyway, less policy tightening will be required”. Votes of both these members are consistent with their views expressed so far that downside risks to growth far outweigh upside risks to inflation, and there is a need to avoid the overshooting of tightening to achieve price stability.

Despite a definite slowdown in the pace of tightening (from 50 bps to 35 bps), and a fall in the global Brent crude price from $86-87/bbl on December 1 to $79.35 on December 6, the yields on government bonds posted a sharp increase on December 7, as the MPC said it would continue to focus on withdrawal of accommodation. However, the RBI’s decision to extend the held-to-maturity dispensation for banks of 23 percent of their net demand and time liabilities by a year to March 31, 2024 was a positive move for bonds and capped the rise in bond yields. Currently, higher supply of bonds due to the large-sized government market borrowings and muted demand from banks are the factors weighing on the bond market sentiment.

According to the RBI Governor, the weighted average lending rates on fresh and outstanding rupee loans have increased by 117 bps and 63 bps during the period May-October, 2022. But the actual increase in home loan rates has been much sharper than the weighted average increase. According to the realty experts, the December 7 hike in the repo rate will further impact EMIs (equated monthly instalments) and reduce home affordability. While the demand for luxury homes may not see much deterioration, the demand for affordable homes and small-ticket home loans will get negatively impacted. The Knight Frank Affordability Index has recorded a cumulative deterioration of an average of 3 percent across India since the beginning of the rate hike cycle.

As developmental measures, the RBI has taken a few consumer-centric steps by adding a single block multiple debit feature in the Unified Payment Interface (UPI) and by including a wider variety of recurring and non-recurring payments under the Bharat Bills Payment System (BBPS). This will facilitate the use of these systems not just for plain cash transactions but also for investment or travel and hotel booking needs, etc. This will take forward the nation’s digitisation journey.

The policy rate hike of 35 bps augurs well for the Indian Rupee. The forex market participants have interpreted the policy as slightly hawkish, and there was some dollar selling by the exporters after the announcement. The RBI Governor’s statement that the rupee has appreciated by 3.2 percent in real effective exchange rate terms during April-October, 2022 will improve international investors’ confidence in rupee-denominated assets.

While discussing the inflation outlook, the RBI Governor said they will keep Arjuna’s eye on the evolving inflation dynamics and be ready to act as may be necessary. However, given the intensity of global headwinds and the impact of past tightening on domestic growth, a need will arise sooner than later for Arjuna to shift his eye from inflation to growth.

Rupa Rege Nitsure is Group Chief Economist, L&T Financial Services. Views are personal, and do not represent the stand of this publication.