Households' battle against rising interest rates and soaring inflation just turned fiercer given the global recessionary fearstorm is upon us. The RBI indicated as much, unequivocally pointing to the 'uncomfortably high' inflation on Friday after it raised key policy rate by 50 bps, taking the repo rate to 5.4%.
Analysts had forewarned us that, a 25-35 bps rate hike indicates inflation has peaked, while an aggressive 50 bps implies that the worst of the inflationary episode was yet to pass.
Friday's rate hike only confirms how inflation perched itself firmly above the central banks' upper tolerance band of 6%, and will likely stay there at least until December. Governor Shaktikanta Das didn't mince words to validate that India was indeed 'grappling with high inflation.' The inflation trajectory was now at a 'decisive point,' he read out, expressionless, during his Friday morning briefing and how such sustained high inflation could destabilise inflation expectations and harm growth in the medium-term. Good luck, to us.
We are almost mid-way in the ongoing rate tightening cycle, but RBI's Monetary Policy Committee (MPC) dismissed calls of shifting policy stance to neutral from accommodative, though it reiterated its focus on Withdrawal of Accommodation (of pandemic-era liquidity).
Domestic inflation is heavily contingent on monsoon, evolving geopolitical, global commodity and financial markets, so FY23 estimates remain unchanged at 6.7% though, it's expected to soften next fiscal with Q1, FY24 estimated at 5%.
While Das noted that there were signs of softening of domestic inflationary pressures, he maintained caution citing 'significant uncertainties', perhaps with the Russia-Ukraine war-led inflation shocker remaining fresh in mind. "In such a milieu with growth momentum expected to be resilient despite headwinds from the external sector, monetary policy should persevere further in its stance of withdrawal of accommodation to ensure that inflation moves close to the target of 4% over the medium-term, while supporting growth," he said.
Taking Friday's 50 bps rate hike, the cumulative increase so far stands at 140 bps (as against the US Fed's 225 bps hike) and takes repo back to pre-Covid levels of 5.15%. The MPC also revised the Marginal Standing Facility (MSF) and bank rates to 5.65% from 5.15%, while SDF rate is adjusted to 5.15%.
With this, the RBI has moved a step closer to its desired level of real rates. Its June bulletin estimated India's natural interest rate at 0.8-1% for Q3, FY22 and when the real policy rate is at, or close to, the natural rate, monetary policy is deemed neutral. It means, repo rate of 5.75-6% with inflation averaging within 4.5-5% in FY24 could be in sync with the natural interest rate.
Minutes after the announcement, yields on 10-year bonds shot up 7 bps to 7.23%, while the rupee traded above 79 against the dollar. Das, though, reminded that rupee fared better than many reserve currencies or Asian currencies. "Depreciation of rupee is due to strength of the dollar, rather than any weakness in India's macro fundamentals. Remain focused on maintaining the stability of the rupee," he observed.
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Meanwhile, India's growth recovery has been resilient despite intensifying headwinds, but weakening global outlook, tightening domestic financial conditions and elevated input costs could prove fatal.
Even though domestic economy is showing signs of broadening with bank credit, urban demand, capacity utilisation and government's capex moving in line, according to Das, the successive shocks to the global economy were taking a toll on the Indian economy and the globalisation of inflation was coinciding with de-globalisation of trade.
The IMF too has revised downwards global growth projection and highlighted the risks of a recession.
India is among the handful of countries with zero probability of slipping into a recession, according to Bloomberg. Despite improving domestic indicators, RBI kept FY23 growth forecasts unchanged with real GDP projected at 7.2%.