RBI in a spot due to price rise, fed heat
Indian markets suffered yet another freaky Friday. As global markets tumbled following the latest US jobs data preceded by Federal Reserve (Fed) chairman Jerome Powell’s hawkish remarks, both Sensex and Nifty dutifully fell 900 and 250 points, respectively. Although markets have priced in another 50 bps rate hikes (by Fed) and 25 bps (by RBI), analysts expect policy-induced volatility to dictate market mood for some time. That’s because, of late, central banks’ forward guidance seems like a person caught between two extreme moods.
Take the US Federal Reserve. From considering a pause in rate hikes just a couple of months ago, Powell did a 180, insisting that rates need to be higher for longer and faster. Pursuing the Fed’s terminal policy rate, which influences all other global central banks’ policy moves, seems never-ending, with the peak rate expectations now touching 5.5 per cent from the current Fed funds rate of 4.5–4.75 per cent.
As it is, global monetary policy actions are unprecedented in size and speed. The likelihood of further rate hikes by major central banks puts pressure on emerging markets, including the RBI, which is already distracted due to the high January inflation print. A 25-bps rate hike in April will take the repo rate to 6.75 per cent. If so, the policy rate differential between India and the US will likely be about the trendline of 100 bps at their respective cycle peaks. But the concerns of RBI’s monetary policy committee’s two external members, who voted against further rate hikes citing growth concerns, need attention.
Indian exports are showing signs of strain, private investment revival is yet to come out of its decade-long slumber, and slowdown concerns persist. Besides, a widening current account deficit is another major challenge. The RBI’s prowess in managing the current account volatility will be tested once again next fiscal. Separately, the dreaded inverted yield curve made a comeback, indicating liquidity tightness. On Wednesday, the yield on one-year government bonds rose above the benchmark 10-year bonds for the first time in about eight years. According to IDFC, the one-year treasury bill rate shot up 400 bps since the RBI’s rate hike cycle began last May and may leave its impact. All these put RBI back in a tight spot, and it must avoid policy errors.