Gird for spillover effect of financial market upsets
The RBI’s latest 50 bps rate hike appears more in response to the US Federal Reserve’s jawboning with super-sized rate hikes and less to do with domestic factors. That’s not to say headline inflation is back to its best behaviour of sub-4%, and while households are forced to do the hard yards, the moot point is if we are past peak inflation. With RBI estimating the crude oil basket to average $100 per barrel in the second half of the fiscal, and if food inflation and global headwinds remain elevated, chances are price rise can have another nasty episode. If so, rate hikes will remain sharper, and the road to positive real rates gets even longer. In June 2019, when the policy shifted from neutral to accommodative, inflation was at 3%, the repo rate was at 5.75%, and liquidity was in deficit. Now, with surplus liquidity and projected inflation of 6.7%, monetary policy is deemed accommodative even though we are in a rate hike cycle. That said, if inflation moderates below 6% by next March, by which point the terminal rate is expected to be at 6.25–6.5%, real returns may turn positive, after all.
Though domestic factors drive monetary policymaking, global events too exert direct influence, as is evident now. The Fed’s outsized rate hikes widened the interest rate differentials significantly, and further hikes could see capital flight, weakening rupee and increasing inflation. While RBI Governor Shaktikanta Das maintained that RBI doesn’t target a specific level for the exchange rate, its actions vary from its stated position each time the rupee hits a new low. Of course, all central banks do that, but what’s concerning is our depleting forex reserves, which Das assured was largely due to revaluation and not actual selling of dollars. Fair enough. But with the dollar at 20-year highs, if the currency market turmoil persists, it’ll test RBI’s mettle.
Lastly, we are yet to overcome the likelihood of a global recession, and fresh fears of global financial market turmoil due to aggressive monetary policy tightening are unsettling markets. India will likely escape any direct fallouts, but it must survive spillover effects. Accordingly, FY23 real GDP estimates are lowered to 7%, but as deputy governor Michael Patra noted, if major economies are worried about a hard landing, we are on the other side, ready for a takeoff. It also means RBI must ensure that high rates don’t stifle growth later.