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Twenty-Sixth EGROW Shadow Monetary Policy Committee Meet held on February 03, 2023


Key Takeaways

  1. India is in a relative "bright spot" in the world economy,
  2. The WPI and CPI both have come down to be in the tolerance range of the RBI.
  3. There is no macroeconomic narrative that established a causal relation between monetary tightening and inflation decline.
  4. The Rupee is coming under pressure again as rising commodity prices pressure the current account deficit (CAD), and the rotation of funds away from India creates funding pressures for India.
  5. The China reopening could challenge production in India.
  6. In the current EBLR regime, hikes by the RBI are being passed on by the banks to customers almost immediately, causing additional pressure on home buyers and industry, especially MSMEs.
  7. Liquidity in the banking system has tightened materially during FY23 and thus it should be eased in 2023-24.

Recommendations of EGROW Shadow MPC

Members of EGROW — 6

Repo Rate:
Increase by 25 bps — 3
No Change — 3

Guests — 2

Repo Rate:
Increase by 25 bps — 2

Detailed Views by Members of the EGROW Shadow MPC

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

The focus has to be on policy. The high global inflation had nothing (precious little) to do with monetary policy. It had to do with commodity and supply constraints. If that is the case, we need to first consider whether should we take a step ahead or not. Policy has to be a function of the real interest rate . Post 2008, the real policy interest rate for West has averaged around -1 percent, for emerging economies around 0 percent real. The likely inflation rate by the end of this year might hover around 4 percent. A 6 percent repo will yield a 2 percent real rate, almost as high as the highest ever experienced in India (2017 to 2019). Many of the factors discussed are fiscal in nature. In case we are assuming Fiscal deficit causes inflation, that is not the case at present with fiscal deficits in a contractionary stage. Commodity prices are also declining. Hence, pause for this time.

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

I recommend a pause in the hike of Repo Rate for various reasons. First, the inflation rate is rapidly moderating within India and is now within the band of IT. Second, globally, the inflation rate has rapidly declined, and consequently, the hike in policy rate in the USA is no more rising aggressively. So, the urgent need to match the Fed rate is no more there for India's central bankers. Further, I am convinced that the substantial increase in the inflation rate in the US was because of the Geopolitical reasons and the aggressiveness in raising policy rates have nothing to do with recent moderation in inflation rates. The inflation in the US, Euro or UK has declined after the world production and supply, have adjusted to the year long Russia-Ukraine war.

Third, within our country, the economy is performing extremely well and the continuation of fiscal consolidation path of the Union Government substantiated that position. The correction is higher in the revenue deficit compared to Gross Fiscal Deficit, signifying good quality adjustment. The expansion in the capital expenditure during the year also reflects robust growth projections for the ensuing year. The debt to GDP ratio, compared to other countries is low, implying enough fiscal space is available to the government within India. Fourth, the immediate performance in the industrial sector is not very encouraging, and that needs to be spurred. The private investment is suffering. And risky winds could blow from the wild west, dampening export prospects of India. In such a situation, rising interest rates, unnecessarily, may not be good for the recovery phase of domestic economy.

Fifth, the banking sector is performing well. The NPAs are very low, with gross at 7-year low and Net at 1.3 percent. As of now, there is a steady flow of deposits and lending. As the economy is doing well and expected to do better, lending rates should not rise higher to deter much-needed fresh investment in industry.

Sixth, on the external sector, the depreciation of the Rupee continues but is much less than that of many economies because of high growth rate recorded by Indian economy. The depreciation should be allowed to continue to correct the balance of trade through market forces. The intervention through interest rates may not be effective. The capital outflow because of interest rate differentials would have been exhausted by now, while a promising robust India growth story must be taking roots.

Seventh, the price of oil is lower than anticipated in the beginning of the year, and is projected to lower further. Thus, CPI inflation is expected to go down further in 2023-24, as geopilitical situation improves and supply chains recover.

Finally, I want to flag 2 issues - a) The transmission of the monetary policy is very efficient in Advanced economies. In case, these countries reverse the hikes, correction will be faster there. In emerging countries like India that efficiency is lacking as markets are not well developed. b) Advanced Countries have the resources and strength to face the engineered expected recession, high unemployment and sacrifice ratio. That may not hold good for EME's like India.

To conclude, I also recommend a neutral stance with a pause. This will facilitate to create a conducive environment for growth impulses in the economy.

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

We expect the RBI to hike rates by 25 bps each on February 8 and April with the Fed set to raise 25 bps each on March 22 and May 3. Although the inflation imperative is met, the RBI cannot ignore Fed tightening without INR weakening. After the Fed pauses, the RBI should be able to cut 100bp in 2HFY24. The RBI should also cut CRR by 1 percent on February 8 to infuse liquidity.

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

2023 began with elevated fears of a sharp slowdown or hard landing in major economies across the world. However, in recent weeks, these fears have begun to slightly moderate on the back of relatively resilient demand in the US and EU, easing of energy crisis in the EU and the re-opening underway in China. The China re-opening (Growth estimated at 5-5.5 percent in 2023 from 3 percent in 2022) is seen to be positive for global growth and in easing supply chain disruptions further. The IMF’s growth projections show a slowdown in global growth in 2023, although the extent of the slowdown in now perceived to be slightly lower than earlier estimated (IMF projects GDP growth at 2.9 percent in 2023 (earlier forecast of 2.7 percent) vs. 3.4 percent in 2022. We expect India’s GDP growth at 5.8-6 percent in FY24 down from 6.8 percent in FY23. Inflation in major economies is also beginning to show signs of peaking, lessening the need for further aggressive rate hikes by major central banks. The US Federal Reserve (Fed) is coming to end of its rate hiking cycle and is likely to pause at 5-5.25 percent (current Fed fund rate at 4.75 percent). Elsewhere the European Central Bank (ECB) is likely to hike rates by another 100-150 bps (current rate at 2 percent) and the Bank of England (BoE) by 50-100bps (current rate at 3.5 percent). While central banks are closing in on the end of their rate hiking cycle, financial conditions are expected to remain tight in 2023 as central banks continue with quantitative tightening and being unlikely to deliver rate cuts in 2023 despite the growth slowdown as inflation is expected to remain above their target. That being, said, the key upside risk to inflation also comes from China, traditionally a large consumer of commodities. Most industrial metals – copper, aluminium, steel—have rallied in anticipation of the Chinese economy going full throttle in a couple of months from now as the COVID wave abates. This will be on both the markets’ and central banks’ minds as they assess and estimate the net effect of supply side-easing from China and demand side pressures of key prices on the back of reopening. Monetary policy recommendations

  • Despite moderation of headline inflation, core inflation remains elevated. In fact, within food itself major categories like proteins and cereals have picked up. Services inflation remains sticky and high. Thus, there is no macroeconomic narrative that established a causal relation between monetary tightening and inflation decline.
  • The Rupee is coming under pressure again as rising commodity prices pressure the current account deficit (CAD) and the rotation of funds away from India creates funding pressures for India.
  • The China risk – in pushing up inflation and attracting flows from India – is intensifying.
  • Growth might be moderating but not fast enough to make absorption of more rate hikes difficult.

RBI should hike the repo rate by 25 bps and leave open the room for another 25 bps in the next policy. The policy stance should change to neutral. We recommend a comprehensive forward guidance on system liquidity going forward.

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

While growth indicators are beginning to show early signs of slowdown amidst global headwinds, high borrowing cost and fading pent up demand, uncertainty with regard to inflation trajectory is expected to keep inflation as key priority for the central bank. We expect real GDP growth to slow down to 5.6 percent in FY24 from 6.8 percent in FY23. However, inflation is expected to remain high at 5.2 percent. We thus expect the MPC to slow the pace of rate hike to 25 bps in the upcoming policy and pause thereafter in FY24. Meanwhile, given the expected liquidity tightness in FY24, we expect a CRR cut of 50 bps sometime during mid-year followed by some OMO purchases to offset the tightening liquidity conditions.

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

I vote for a pause in this policy rate in the February MPC meeting. RBI has moved to a lower gear in the December meeting when they hiked the repo rate by 35 basis points instead of 50 basis points in the previous three occasions. Views of the MPC members appear divided. While some of the members continue to sound hawkish given persisting high headline and core inflation, in the minutes of the December MPC meeting, a couple of members hinted at adopting a more nuanced stance as regards further hike in the policy rate.

Since the last MPC meeting in early December, food inflation softened materially, offering some relief for the time being, especially for poorer people. However, amid the current EBLR regime, hikes by the RBI are being passed on by the banks almost immediately, causing additional pressure on home buyers and industry, especially MSMEs.

In the summer of 2022, when the RBI started its hiking cycle, the repo rate was at 4 percent, far from its usual zone of 6-7 percent. Now, with the repo rate are at 6.25 percent and the headline inflation in a softening track and within the RBI's upper tolerance band, the urgency of further hike on the part of the MPC is substantially lower.

We expect headline CPI to move sub-5 percent in Q2 of the calendar year. That would imply real policy interest rate at well over 1 percent. Of late, the INR has also signs of better stability than say 3-4 months back. While GDP growth remains decent, it will likely hover around 5.5 percent in FY24. Thus, overall, there are several reasons to remain careful before delivering further hikes in the policy rate, in my opinion. I would recommend keeping the repo rate on hold at the moment and allow the economy to absorb the large 225 basis points of hike that was delivered in just about six months since May 2022.

Admittedly, recovery in China is the big elephant in the room as regards prospects of global recovery and trajectory of inflation in the coming months. In case, inflationary pressures re-emerge due to a rapid recovery in China, there might be a case of another bout of rate hikes in India. But, at the moment, against the backdrop of the current growth and inflation dynamics, I feel the case for a pause remains strong, even though a 25 basis points hike in the policy rate seems to be the street consensus.

Liquidity in the banking system has tightened materially during FY23. We expect better liquidity support from the RBI using OMO and potentially even by lowering of CRR in the new financial year. Temporary relief on CRR front in the final fortnight of March cannot be ruled out either, if the liquidity situation turns further tight by that time.

Guest Panelists – Specialists from Market and Members from ASSOCHAM:

1) Shri S. C. Aggarwal, Senior Member, ASSOCHAM & CMD, SMC Group

The RBI is going to have meeting between February 6, 2023 to February 8, 2023. The Union Budget was good for capital investment and allocation. 10 Lakh Cr. allocation was done with a multiplier effect. In FY 23 it is expected to have fiscal deficit of 5.9 percent. FM also mentioned fiscal deficit prudence. We have seen 225 bps hike since April 2023. Banks NPA have reduced to 5 percent. Inflation in November, 2022 was less than 6 percent. RBI may increase rates by 25 bps. It should be last hike and then pause should be there. We should also see an change in stance from accommodative to neutral.

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

We expect a 25bps rate hike from the RBI and then a pause all through FY24.While this rate hike in essence would not be essential, it becomes important to maintain a reasonable gap on policy rates between the RBI and the Federal Reserve in the US. And this incremental 25bps would be in line with the metric of 50 percent of transmission of Fed rate hikes that the RBI has maintained so far.

Inflation (CPI) is expected to remain rangebound for an appreciable part of FY24 after an initial drop to the 5 percent+ handle. Incrementally, there do appear to be upside pressures in the form of an increasing probability of an El Nino risk this year and some MSP price support from the government ahead of the general elections in 2024. Therefore, it would be appropriate for the RBI to hold on to its policy rates for the full FY24 fiscal year, even if the Fed/ECB hint at easing rates towards the latter half of 2023 (like markets expect).

Against this backdrop, a 25bps rate hike and done and hold on to rates through FY24. Would be good to leave the commentary on rates open and data dependent, with a hawkish tinge that keeps markets also reassured that the RBI is constantly assessing the situation; avoiding any complacency on the markets' part.

One point of concern however is the funding of the current fiscal deficit through small savings. FY24 is seeing an increasing dependence on small savings at a time when only 40 percent of the small savings assumption for budgeted FY23 small savings numbers have come through. The RBI may have to strongly consider supporting liquidity and yields through their OMOs.