The RBI's monetary policy acquired an Ernest Hemingway touch, but with a twist. Given persistent inflation, global headwinds and supply shocks, policy rates are moving only two ways -- 'suddenly first and then gradually.'
On Wednesday, Governor Shaktikanta Das delivered his forewarned 'no-brainer' 50 bps hike rake hike taking the policy repo rate to 4.9%. Still, the benchmark rate stands below the pre-pandemic level of 5.15%. Taking the off-cycle 40 bps hike last month and 40 bps increase in Standard Deposit Facility in April, the effective increase stands at 90 bps.
In spite of these hikes, policy rates are a mighty 180 bps away from real rates becoming positive given FY23 inflation projections are revised a full 100 bps upwards to 6.7% overriding RBI's previous estimate of 5.7%. And if you consider bank deposit rates, which often tend to drop first during rate cuts, but spike with unending delay during rate hikes, we are a good 200 bps (or more) away from positive real rates.
The touchdown is a long way even as the Monetary Policy Committee (MPC) is attempting the difficult task of normalising policy in these non-normal times. As the Governor explained later, 'normal conditions' relate to a state where overnight call money rates are aligned with the policy repo rate (now at 4.9%). Currently, overnight rates are hovering a little over 4%, so you get the drift about incoming rate hikes.
Worryingly, the central bank confirmed that headline inflation will whack us all breaching RBI's upper tolerance band of 6% for three quarters straight, or until December only to settle slightly below 6% by March 2023. But Das remained elusive on the timing of regaining the 4% target given the 'extremely uncertain outlook.'
Curiously, the MPC also left us all in the dark, refraining from publishing its policy stance on rates, which is typically neutral, accommodative or tight.
Nothing like this has happened before. The Governor, however, explained that the policy stance wasn't dropped altogether and given RBI wasn't 'bound by stereotypes and conventions,' the MPC took all the leverage it has to temporarily abandon its rate stance and instead focus on withdrawal of accommodation because liquidity is way above pre-pandemic level. Policy wonks, however, were quick to fill us in that rate hikes will be spread throughout the fiscal with at least 25 bps hike coming in August, which will take the benchmark repo to the pre-pandemic 5.15% mark.
In his closing remarks, Das stressed on the need for preserving price stability to ensure growth and how Wednesday's rate hike imparts credibility to the medium-term inflation target. He vowed to bring inflation down closer to the target, but whether it's 4% or 6% was left open for interpretation.
Between February and April, headline inflation shot up by 170 bps, but by RBI's own admission, much of this increase was due to a series of supply shocks linked to the Russian-Ukraine war. As Das reiterated, about 75% of the increase in FY23 inflation projections was attributed to food inflation, which in turn is triggered by external factors. Even a non-scholarly view tells us that no amount of policy rate tweaks will lower global crude, commodity or food prices driven by war-related supply pressures.
So why are global central bankers racing to raise rates to counter a problem they clearly cannot solve? And at a time when supporting economic recovery should have been assigned priority. So far this year, more than 45 global central banks raised rates with more joining in.
The answer, as one of the deputy governors of the Bank of Japan recently noted, stems from the experience of the Great Inflation episode of the 1970s when monetary policy became the almighty cornerstone for price stability, and how inflation expectations are crucial to sustaining inflation. Since then, central banks have been deploying rate cuts/hikes to influence and stabilize inflation expectations.
According to Das, inflationary pressures became broad-based, driven by adverse supply shocks of course, but there are growing signs of a higher pass-through of input costs to selling prices. So the MPC believes that sustained high inflation could unhinge inflation expectations and trigger second-round effects and hence Wednesday's 50 bps rate tightening will likely keep inflation expectations in check. How many such future rate hikes are needed to anchor inflation expectations? There are no easy answers. The government did extend its 'big-bro helping hand,' although belatedly, with excise duty cuts, import duty waivers, enhanced subsidies and export bans, to ease price pressures, but it'll be a while before these can have any material impact.
As for growth, positives will be offset by negatives, neutralising the impact. In the MPCs assessment, a normal monsoon will spur rural consumption, while urban demand will get a boost from the rebound in contact-intensive services. Overall, there's optimism among consumers, households and businesses. The downside comes from spillovers from geopolitical tensions, elevated international commodity prices, rising input costs and tightening of global financial conditions. Taken together, the impact on Indian economic growth will be neutral and so forecasts have been retained at 7.2%.