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Thirtieth EGROW Shadow Monetary Policy Committee Meet on September 27, 2023


Recording of the event

Key Takeaways

  1. India continues to be the fastest growing economy in the world.
  2. In recent months, performance of Fiscal, Industrial and Financial Sector is encouraging.
  3. The fear of inflation continues to haunt all central banks.
  4. Supply side shocks continue to be a concern.
  5. Tight liquidity is impacting the domestic market.
  6. Bond inclusion, a positive development, could help India in diversifying investors.
  7. US economy is slowing but the fear of recession is receding.
  8. Repo rate significantly related to US.

Recommendations of EGROW Shadow MPC

Members of EGROW- 6

Repo Rate

Extended Pause – 3
Hawkish Pause – 2
Pause with preparedness to lower – 1
Decrease - 0

Guests- 4

Repo Rate

Extended Pause – 4
Hawkish Pause – 0
Pause with preparedness to lower – 0
Decrease - 0

Detailed Views by Members of the EGROW Shadow MPC

1) Dr. Surjit Bhalla, Former Executive Director, International Monetary Fund

Three, brief conclusions:

First, that the news from the US is confusing. Inflation rates (month on month and therefore excluding the base effect) are expanding at a 2.5 % rate, and bond yields are the highest since 2007! With this low inflation rate, the real rate in the US is somewhere close to 2.5 percent and historically this rate has not lasted for very long. We also don’t know whether Japan and China have still some selling left.

Second, I am not in the camp that thinks there is a recession coming in the US. If you look at the indicators (months to recession since the last rate hike), this has steadily increased from just 2 months or so since the last rate hike, to now months in the high teens. In other words, rate hikes are less and less a predictor of recessions; Does this mean that we don’t know much about the determinants of inflation?

Third, given the highly confusing and uncertain position, the RBI should continue the pause.

2) Dr. Charan Singh, CEO and Director, EGROW Foundation

The growth story of India is very interesting. The second quarter of the financial year, end of September, is coming to an end. The busy season, the festival season, has started and the economy is expected to do better. India, which has potential of growing at about 8 percent, is projected to grow in the range of 5.5 percent to 6.5 percent in financial year 2024. Hence, this is a matter of concern because India is still way behind its potential growth level.

There has been a rain deficit during the recent monsoon across the country. This could impact production in agriculture sector, both Kharif and Rabi.

The industrial sector has been doing reasonably well. The IIP, up to July 2023 is performing moderately with scope of improvement. In the manufacturing sector, the growth is 4.6 percent; in the electricity sector it is 8 percent, while in mining it is 16.7 percent. These growth performances are certainly better when compared with July 2022, but there is potential for better growth especially in the manufacturing sector. Similarly, primary goods and infrastructure are doing well in July 2023 compared to July of the previous year. But in the capital and intermediate goods segment performance could have been better. The situation in consumer durables is difficult as the growth rate in July is in negative zone, while the consumer non-durables are doing better at 7.4 percent. The performance of 8 core industries is also mixed. The coal production is high as also crude and natural gas while refinery and fertilizers need to be strengthened. The industries associated with infrastructure - steel, cement and electricity are recording a robust performance.

The fiscal situation of the government is robust despite the mixed performance in the manufacturing sector and uncertain situation in the agriculture sector. The amount of GST collection recorded an increase of 11 percent in August 2023 to Rs.1.6 lakh crore from Rs.1.4 lakh crore in August 2022. The GST revenue from domestic transaction are 14 percent higher over the previous year. Gross direct tax collection, as on September 16, 2023, increased by 18 percent while the net direct tax collection is 23.5 percent. Thus, there is a healthy growth in the fiscal sector.

In the banking sector, aggregate deposits are increasing by 14 percent and are at Rs.193 lakh crore while the credit is expanding at the rate of 19.8 percent, year-on-year, and is at Rs.150 lakh crore.

On the external sector, the situation is worrisome as growth in the advanced countries is slowing down implying that the absorption from India is obviously declining. In July, overall exports are estimated at USD 59.4 billion. The trade deficit in July is USD 8.4 billion compared to USD 15.2 billion in July 2022. The exports of iron-ore are up by 962 percent while electronic goods have increased by 13 percent, and ceramic products, glassware by 20.8 percent. The exports of agricultural goods has also been improving - fruits and vegetables by 19 percent; oil meals by 34 percent; and rice by 5 percent over the year. The amount of Foreign Exchange Reserves (FER) of India at USD 593 billion would need to be shored up in view of rising uncertainty in the global economy. These reserves are essential for building confidence in the economy as well as maintaining an armour of reserves in face of any speculative adventure. The building up of FERs can take a few months as the exercise has implication for liquidity in the economy which will have to be managed. Until then the RBI would have to carefully watch the exchange rate which is range bound around Rs. 83 per USD in recent period. The increasing uncertainty would imply that there is equal possibility of Rupee appreciation as well as a depreciation. However, given the inflationary gap between the two countries over a period of medium to long term, probability of rupee depreciation is significantly higher whenever economic conditions normalise. The uncertainty in the global market is also enhanced by the behaviour of commodity prices specially oil prices which has already increased to USD 90 per barrel and expected to cross USD 100 per barrel shortly.

On the price front, data released in mid-September reveals that Consumer Price Index (CPI) for all commodities is 6.8 percent, while food CPI is 9.9 percent. Similarly, on the Wholesale Price Index (WPI), prices, for all commodities is low at -0.5 percent while food WPI is 5.6 percent. Thus, on the food front, the prices under CPI are high and for reasons which are well known, like prices of vegetables specially tomatoes, and pulses. These prices are related to supply side rather than the demand side.

The interest rate cycle in Advanced Economies (AEs) is confusing. ECB has increased the policy rate by 25 basis point, while the Fed Reserve and Bank of England are continuing with the extended pause. The reversal of the interest rate cycle in the US has been ‘seemingly’ postponed to 2024 as the fear of recession has receded significantly.

In the current year, 2023, while inflation is coming under control in AEs, though still not at their long term 30-year average, the probability of the ‘extended pause’ not continuing for long is always looming on the policy horizon adding to the intense uncertainty for EMEs. Interestingly, even if inflation increases due to supply side reasons, the possibility of a hike in interest rates is always present according to recent policy trend. However, if inflation continues to be benign and converging to the long-term average of less than 2 percent in AEs, then there is a possibility to start lowering the policy rates. The supply side disruption is also expected to be low now given that the phenomenon of war has stabilised. Hence, the prices in AEs may continue their trajectory southwards. In such an eventuality, the possibility of the hike in interest rates by the U.S. Fed is minimum. The Indian interest rates are highly co-related to the US policy rates for many reasons like high trade relations, considerations of exchange rate and movement of capital.

India is passing through a challenging time. While the growth rate is the highest amongst the nations, it is below its long-term potential. The young demographic dividend that India has, is available only for next 20 years. Therefore, there is no time to delay the optimal utilisation of the available labour force if the dividend has to be ensured and demographic disaster is to be avoided. To ensure maximum benefit of the demographic dividend, the interest rates which are higher than the normal times, needs to be reversed so that the investment cycle in the country kick-starts again. Household savings need to be invested, both by banking and non-banking finance companies. The interest rate is a major consideration for long term investment. Therefore, lowering the interest rates would be beneficial for the investment in the economy, and take the growth rate to its potential best to 8 percent and above. Further, given that the economy is in the election cycle and the budget in February 2024 would only be an interim budget, while the full-fledged budget would have to wait until February 2025, it will be helpful if low interest rates are maintained in the economy during the election phase. The RBI would do well to start considering the reversal of the interest rate cycle at the earliest after the policy of October 6, 2023.

3) Shri Indraneel Sen Gupta, Head of India Research, CLSA

We are looking at a pause in the October policy. Although inflation has pierced the 2-6% mandate, it is driven by a rain shock. Core has slipped to 5% levels.

We expect the RBI to cut in December if the Fed pauses at 5.5%. If the Fed goes to 5.75%, the RBI should raise 25bp by December and cut from February.

4) Ms. Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank

The global environment is extremely uncertain, as US growth remains resilient and inflation appears to be facing some upside risks. The Federal reserve has accordingly stepped up the narrative of higher rates for longer. The US Dollar and bond yields have been on a uptrend. Narrowing interest rate differentials to record low levels poses severe financial instability, thereby warranting a cautious approach by the RBI. Further, domestically too food inflation risks along with rising crude oil prices remain a concern. We therefore recommend the MPC to maintain a hawkish pause. Meanwhile, the overnight rates are already hovering near the upper end of the LAF corridor (at MSF rate levels) since the last two weeks—suggesting an effective temporary rate hike. We expect the RBI to prefer keeping the short-term rates elevated in the near term, given the pressure on INR and underlying inflationary risks. We expect the MPC to maintain status quo on repo rate atleast through FY2024.

5) Shri Abheek Barua, Chief Economist and Executive Vice President, HDFC Bank

Pause. No change

6) Shri Siddhartha Sanyal, Chief Economist & Head- Research, Bandhan Bank

Pause. No change

Guest Panelists – Specialists from Market and Members from ASSOCHAM:

1) Shri Rajkiran Rai G., Chairman, ASSOCHAM, National Council for Banking and MD, National Bank for Financing Infrastructure and Development.

My views on rate cut expectation:

Even if the RBI cuts the rate may be after 2-3 quarters, transmission of rate reduction in the Banking system will take longer. Particularly for large and Medium Corporates who are in MCLR regime. The reason being mobilizing deposits has been very competitive and we see Banks mobilizing deposits at above 7% level. Such high cost of deposits will not allow MCLR to come down quickly.

Overall ecosystem has accepted the present level of interest rates and we are seeing good credit growth. My impression is that growth prospects are not affected by the present level of interest rates. So ‘higher for longer’ may not affect our growth prospects if other factors are favourable.

2) Shri Arjun G. Nagarajan, Chief Economist, Sundaram Mutual

Expect a continued hawkish pause from the RBI in the upcoming monetary policy as well.

We still expect RBI Repo rates to remain unchanged all through FY24.

We still expect the start of the RBI's rate cuts to begin end-Jun'24 quarter.

The rate cut cycle would be shallow and not more than 50-75bps.

However, if the start of the Fed's rate cycle is delayed, it would delay the start of RBI's rate cut cycle as well.

The two primary drivers of the RBI's action on the Repo rate remain the Fed policy and India's trade deficit (currently elevated).

Bond inclusion is an appreciable positive, but the related flows would only come during Jun'23 quarter of next year.

Any FII inflow momentum India may receive at that point in time would be largely mopped up by the RBI to strengthen its forex reserves.

Therefore, do not expect any notable appreciation in the Rupee; only a softer level of depreciation.

GDP growth in India must be seen using 4Yr % CAGR and sequential momentum. Both suggest resilience with growth broadly flat from Q4FY23.

High frequency numbers show more strength and resilience than seen in the GDP numbers.

Finally, on rural demand, while the poor rains are likely to see a drop in yields, strong rural wage growth and rural spends could likely offset the negative impact.

3) Shri Madhav Nair, Co–Chairman ASSOCHAM, National Council for Banking and CEO-India, Bank of Bahrain and Kuwait

I recommend an extended pause from RBI this time around for the following reasons:

Inflation remains elevated: While the CPI inflation dropped to 6.83% in August as compared to 7.44% in July, it still is well above the RBI target of 2-6%.

In my view the uneven progress of Southwest monsoon may put some pressure on food prices in the short term.

Monsoons this year has been erratic and August was probably one of the driest months in decades, on a positive note in September the rainfall deficit has reduced significantly.

There is also an uncertainty around the crude prices which could have a bearing on the inflation levels.

Considering the above my view is that the rates should remain unchanged for the time being.

4) Shri Rajan Pental, Co-Chairman, ASSOCHAM, National Council for Banking and Executive Director, YES Bank Ltd

India’s Q1FY24 GDP and GVA growth was at 7.8% YoY. We can expect GDP growth for FY24 at 6.1%. Exports are expected to remain weak on account of weakening global growth. There are risks to the food and overall inflation outlook from volatile global food prices (vegetables, cereals, and pulses), increased crude oil prices and skewed monsoon, all of which require close monitoring; thereby raising inflationary expectations as evidenced by sharp rise in US treasury yields. RBI is expected to be on an extended pause and any rate cut expectation are pushed out to H1FY25.

The economic projection of the Fed presents a picture of continued resilience of the US economy with the GDP forecast for 2023 revised up sharply to 2.1% from the earlier 1.0%. Fed held rates unchanged at 5.00%-5.25%. Further rate increases in 2024 are not expected and US rates are likely to stay “higher for longer”; providing comfort to the RBI to hold repo at 6.50%.

WPI inflation registered a negative growth of 0.5% YoY in Aug-23; on a sequential basis it increased by 0.3%. On a YoY basis, fuel inflation declined by 6%. Crude oil prices have crossed the USD 90 pb mark in September on rising supply concerns. As commodity prices continue their gradual upward march, we see this as a key risk building up further into H2FY24. Headline CPI in Aug’23 at 6.8%, down from 7.4% in Jul’23; decline led by vegetable prices. LPG price cut by 20% is positive but unlikely to have a significant impact as LPG weight in CPI is 1.29. We expect FY24 Headline CPI to be around 5.4% and likely to miss RBI target of 4%.

Alternatively, RBI may prepone the rate cuts to boost domestic consumption and bolster capex, however there is a trade-off with outflow of US dollars. We are sure that MPC will consider all the factors will take a balanced and cognizant stance.