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Twenty-Third EGROW Shadow Monetary Policy Committee Meet held on August 1, 2022


Recording of the Event

Key Takeaways

  • Growth has been impacted by Russia-Ukraine war
  • Post Covid supply chain disruptions may last longer than current year.
  • Real Interest Rate differentials with the USA need to be taken into account
  • Foreign Exchange Intervention may not help in support of the rupee
  • Policy Rate hikes in the USA are being reconsidered
  • US recession can reduce India’s growth by 100 bps
  • Too much global uncertainty, which can result in USD getting further strong

Recommendation of EGROW Shadow MPC

Members of EGROW – 5

Repo Rate

  • Increase by 50 bps - 3
  • Increase by 25 bps - 2

Guests – 3

Repo Rate

  • Increase by 50 bps - 1
  • Increase by 35-40 bps - 1
  • Increase by 35 bps - 1

Detailed Views by Members of the EGROW Shadow MPC

1. Dr. Arvind Virmani, Chairman, EGROW Foundation

Since late 2020, post covid supply chain disruptions have been low in India while it is high in the United States and intermediate in the rest of the world. RBI should change over to a neutral stance, as the repeated supply shocks could have long term effects. The other issue is the demand side effects of the recent US fiscal stimulus going beyond the point of generating a safety net.

As asserted, the GDP growth rate of 7.5 percent (+/-0.5) was likely to be the outcome and if RBI agrees with this, then a neutral stance is justified.

The growth recovery in Q1 was led by the demand for contact services. The implication for the RBI is to make sure that the supply constraints do not affect the recovery in services. If this recovery in services proceeds in India, then some of the pressure will be taken off the goods, especially considering the international demand for goods.

The Ukraine war and oil shock added to these earlier uncertainties, and this is expected to continue for another year. Considering this, the uncertainty range on the GDP forecast may be increased to +/- 1.0 from +/- 0.5 percent, as asserted earlier. One of the implications of this is that the projected recovery in Q2 and Q3 may be delayed (especially in housing demand, real estate and private investment).

In the Indian context, monetary policy is not going to have a significant, direct effect on inflation and focus must be on its impact on expectations.

There are two elements that RBI has to focus on:

  1. Real interest differential with the US;
  2. Neutral policy rate.

2. Shri Indranil Sen Gupta, Head of India Research, CLSA

We expect the RBI MPC to hike 50bp on August 5 and a further 65 bp by December. After all, inflation is running well above the RBI’s 2-6% target. While we think inflation is peaking off, we are still looking at 6.3% in March. Just as importantly, we expect the Fed to hike another 125bp. This means that the RBI too will have to hike the rates. It is also clear that higher interests can impact growth. A recession in the US can reduce India’s growth by 100 bps.

3. Ms. Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank

The MPC meets in the backdrop of sharp swings in the markets with the sentiment shifting swiftly from taming inflation to concerns on global outlook. Accordingly, the deliberations will likely be centered around the global monetary policy cycle amidst the outlook for global growth and inflation, recent meltdown of global commodity prices, and the consequent impact on domestic macros especially the external sector risks and the associated pressures on the INR.

We expect a front loaded 50 bps hike in the August policy keeping in view the external sector pressures as global key central banks continue the fight against inflation and as India’s inflation hovers around 7% at least till September . However, the government’s supply side intervention, impact of monetary tightening along with softer global prices is expected to ease inflationary pressures towards the end of the year. We expect inflation to gradually glide towards an average of 5.3% in FY23Q4. Further, FY23Q1 inflation at 7.3% is 20 bps lower than RBI’s estimate in the June policy. And the FY23 Q2 inflation should be 30-40 bps lower than RBI’s estimate of 7.4%. Overall, we expect RBI to realign its FY23 inflation forecast to ours at 6.5%, compared to their earlier estimates of 6.7%. On the growth front, we expect the MPC to retain its GDP forecast at 7.2%.

While we expect the need for frontloaded policy tightening, the terminal rate does not need to be very elevated in the current cycle especially given the idiosyncrasies of the nature of inflation. We continue to expect Repo rate at 5.75% by end of FY23. Meanwhile, we also need to focus on the liquidity stance of the RBI, which needs to be realigned to ensure that the MPC’s operative target rate i.e. weighted average call rate (WACR) is consistently closer to the Repo rate. After a brief spike in overnight rate last week, rates are back towards the lower end of the LAF corridor. Much headway is needed to achieve this goal alongside the policy rate hikes. Such simultaneous actions will ensure real policy rates will be close to the natural rates and hence would equate to a neutral policy stance. Until then, the discussion around the stance seems vague.

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

An increase of 50 bps in repo rate is recommended; the terminal rate should be between 5.75 -6 percent. The monetary policy stance should change from accommodative to restrictive. MPC should tolerate inflation higher than 4 percent for the medium term and should reach this in a calibrated manner. It is important to recognise a higher inflation rate due to external factors and domestic tightening. Concerns regarding low liquidity need to be addressed despite being outside the MPC’s remit. Softer inflation prints than RBI's earlier forecast of 7.3 ,6.9, 6.3 and 5.8 for the 4 consecutive quarters of 2022-23 would be observed. Indian Economy would grow at 7 per cent for 2022-23 and 6.5 per cent for 2023-24.

5. Dr. Charan Singh, CEO and Director, EGROW Foundation

My assessment is that the Repo rate should not increase more than 25 basis points in the next Monetary Policy. I would argue that the Oil prices have started moderating as well as Gold prices. The exports can be impacted because of the depreciation of the exchange rate while the USD is getting stronger, and USD could still appreciate further. There is excess uncertainty globally, and the strengthening of USD and weakening of Indian Rupee could have implications on exports. It is for this reason, probably, that the International Monetary Fund in its latest revision has scaled down the growth of India to 7.4% in 2022 and to 6.1% in 2023. In both the cases, the scaling down has been by 0.8%. The argument that there should be a minimum interest rate differential between the U.S. and India may not be necessary in days to come. The U.S. has aggressively increased its interest rates because inflation is 5 times its normal level but that is not the case in India, where CPI inflation is about 7 percent, just about 100bp outside the band.. Also, of late, there are indications that the U.S. economy is slowing and interest rates will not be raised as aggressively as originally planned by the Fed Reserve. Inflation in the U.S. is also expected to moderate in days to come, given oil prices are now moderating and, therefore, the U.S. Fed may not as aggressively, as originally anticipated, increase the interest rates.

More importantly, given the first round of aggressive interest rate hikes, whatever capital outflow had to take place, has probably taken place. Now, even if there is a slight wider gap in interest rate differentials, it is not necessary that capital will flow out.

Third, inflation as made by the CPI-WPI is certainly above the tolerance limit now. But, if component wise analysis is done, the hike is in vegetables, generally. The rise in oil prices, fertilizers or other commodities have probably played their role. Now, the inflation, if it is only because of vegetables and fruits or paper products, would not get corrected by increase in interest rates.

The latest growth figures for IIP and core industries are encouraging as also high frequency indicators. The Reserve Bank will not like to impact the growth impulses by aggressively raising the interest rates. Therefore, I recommend an increase of 25 basis points in the current Monetary Policy - a rate hike which shows that the RBI is alert as well as does not hurt the growth sentiments.

In case the American data expected to be released on Friday is adverse, and U.S. resumes aggressive correction in their interest rates, then off-cycle, as in the past, the RBI can always increase the interest rate. Otherwise, aggressively raising the interest rates now in an attempt to match the incremental increase of 50 basis points by the U.S. Fed, may harm growth and employment in India.

Guest Panelists – Specialist from Market and Members from ASSOCHAM

1. Shri Siddhartha Sanyal, Chief Economist & Head- Research, Bandhan Bank

We are in the midst of an unusually sharp and short rate hike cycle. Systemically important central banks are hiking rates, including a cumulative 150 basis points hike in the policy rate by the US Federal Reserve since the RBI’s previous MPC meeting in early-June. However, even though the US Fed hiked the policy rate aggressively of late and is expected to hike further in the near future, interestingly, street expectation of rate cuts by the Fed as early as in 2023 has become materially stronger in recent weeks, as reflected in US swap rates. Thus, the current global policy rate cycle looks set to deliver faster-than-usual hikes, albeit with possibility of an unusually quick reversal.

Back home, with retail inflation ruling at 7% and staying above the RBI’s upper tolerance band for two consecutive quarters, the MPC will likely deliver another 35-40 basis points hike this week in line with their recent bias of front-loading of rate action. However, with signs of softening in industrial commodity prices, and activity indicators in the global arena, inflation pressure can be a tad lower towards the end of FY23. The RBI’s terminal repo rate in the current cycle can be around 5.75%, with a modest downside bias.

While a quick turnaround in growth recovery in the near term is unlikely, one expects the other macro headwinds (eg Surging commodity prices and inflation, widening trade deficit, spike in global central bank rates, cross-currency volatility) to soften meaningfully over the next 2-3 quarters, offering better prospects for the financial markets and greater degrees of freedom for policymakers than in the recent past.

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

The current situation is fairly fluid and market moves appear to be headline driven.

But for now, three things seem reasonably clear:

  1. Metals are on the way down, with no incremental surprise spends expected from China
  2. Crude sees near-term softness, natural gas sees more near-term geopolitical uncertainty. On the whole, energy is sticky with more upside uncertainties.
  3. Global heat waves are seen across the world, especially in Europe and domestic monsoons being a bit mixed on spatial distribution. So upside pressures on global inflation and possibly vegetable prices could see some build up.

The RBI's monetary policy can be broken down into the PMC and the RBI. The MPC outcome appears to be a rate hike with some changes in language. Two of the following could be expected, with more probability of the first.

  • A 50bps rate hike with neutral language
  • A <50bps rate hike with hawkish language

From the RBI, there is very likely some commentary on liquidity that could hint at an OMO ahead. This is mainly because systemic liquidity as read by the net reverse repo has dropped to Rs.650bn, from Rs.6.2tr seen during 30 Mar'22. This is a sharp drop in surplus liquidity and this has also pushed up short term rates.

While the RBI might want overnight rates within their policy rate bands and closer to the Repo, the level of surplus liquidity does appear to be on the lower side. This could be a result of RBI action on the currency (selling dollars). However, with more currency pressure ahead (on account of the elevated trade deficit), RBI intervention is more likely, which could drain liquidity even further. This would invariably warrant OMOs from the RBI to keep this excess liquidity from turning negative. Why? because at this stage of nascent recovery on growth, the RBI would like system liquidity to remain in excess, rather than move into a deficit this early; when global uncertainties remain.

The markets appear to be reflecting a reduction in the pace of rate hikes from the Fed, with even expectations of a possible pause in Dec'22. This narrative holding up into the months ahead will depend on US macro data. Especially this Friday's Non-farm Payroll numbers. If the NFP numbers are very strong, this could increase the market expectation of an aggressive Sep'22 Fed rate hike. This in turn would push the RBI to remain hawkish in its narrative on rates as it would want the policy to partly address rate differentials between the RBI and the Fed. This could also push up the terminal Repo rate base case from 5.45%, to a higher level closer to 5.75%.

If the NFP numbers are soft, the Fed's recent narrative of a slower rate hike pace could play out, with the RBI's terminal Repo at 5.45% instead.

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

In the last six months the average inflation has been above 6 percent. In June the monthly average inflation was 7.01 percent. This is above the comfort level. The GST collection for the month of July 2022 was Rs 1,48,000 crore compared to the month of June in the same year it was Rs 1,44,000 crore. The auto sales were promising. The Stock Market performance was also promising as indicated by the Sensex having an index value of 58,000. The sale of shares by foreign portfolio investors has declined in the month of July compared to the month of June. The RBI would hike monetary policy rate by 35 bps in this meeting it is not urgent to hike the policy rate given the conditions of the economy were not bad despite the covid 19 and geopolitical shocks. Even the European Union has recently hiked the policy rates by 50 bps after a long gap. India should maintain the accomodative monetary policy stance.