Price worries. Dissecting the credit policy: Business line 8th February 2023

 The monetary policy was not expected to surprise the markets as a 25 basis point (bps) cut was taken for granted.

However, these days more important than the rate change is the number of votes within the Committee for the decision as well as the commentary that follows. The first tells us that a divided view can go the other way in the forthcoming policies, while the commentary reflects the rationale for the decision.

A divided view is important as it means that there is a strong alternative view especially on inflation trajectory and the efficacy of past rate hikes. The point however is that once the MPC takes a pause, it becomes difficult to raise the rate again if inflation remains high which will be the case going by the trajectory forecast by the RBI for FY24.

Let us try and analyse the commentary. The RBI has increased the repo rate while maintaining the stance of ‘withdrawal of accommodation’.

While the rate hike was expected, the stance was also expected to change to neutral which could have been a precursor to the lowering of the repo rate going ahead. The rate hike was inevitable as inflation though declining is still high and the RBI’s forecast for the fourth quarter is 5.7 per cent.

There is always the counter view that rate hikes take time to deliver and this is why two of the MPC members probably argued against a hike. This could well be the last rate hike in the cycle based on the indications given.

But the retention of the stance indicates that the RBI feels that there is still some liquidity to be mopped up and hence it is not yet time to turn ‘neutral’. Also extending the logic here one can say that this rules out a rate cut in the future too as normally the stance changes first before the repo rate reversal takes place.

Inflation path

With the inflation trajectory for the next year expected to increase from 5 per cent in Q1 to 5.6 per cent in Q4, the RBI’s worries are justified.

Add to this an external shock due to the China factor or an internal one, like a monsoon or crop failure, there could be a another rate hike.

Therefore, the likely implication is there will be a pause going ahead with a possibility of a change later which will be data driven. The RBI, however, has given no overt indication on this and has left it open to the market players to interpret.

The RBI’s growth forecasts appear to be pragmatic and are welcome at a time when several analysts and economists have been talking of rates as low as 5 per cent for FY24.

The IMF, the World Bank and the government have all given numbers above 6 per cent and, hence, the RBI forecast reinforces them. The forecast of Bank of Baroda has been 6-6.5 per cent from the start.

Given that the Indian economy is primarily a domestic demand driven one there is a part decoupling of our growth with that of the Western world. While exports will come down for sure, this will not seriously dent growth prospects and while the economy will move down from the 7 per cent projected for FY23 by the NSO to 6.4 per cent, it would still be reasonably high by global standards.

However, the interesting take is the downward glide path cross quarters from 7.8 per cent to 5.8 per cent. This will be a continuation of the second half of the year performing lower than the first half. It also means that the pent up demand story which played out well in FY23 will not be replicated as the impact of consistently high inflation on consumption will finally tend to dilute slowly the pace.

The inflation forecasts on the other hand will move in a different direction during the year and would increase from 5 per cent in Q1 to 5.6 per cent in Q4. This comes on a base of high inflation in FY23 which normally imparts a modicum of comfort as numbers come in lower.

Notwithstanding this feature, overall inflation would remain above 5 per cent all through the year.

This is assuming there is a good monsoon and kharif crop. Looking ahead, it does look like that we may have to wait longer for the inflation number to come anywhere close to the 4 per cent mark.

Liquidity issue

An issue which has been touched upon by the RBI is liquidity. Presently there is still surplus in the system which affords the stance to be ‘withdrawal of liquidity’.

However, in FY24 there will be repayments of the term repos which were brought in during the pandemic in the form of LTROs and TLTROs, which will cause a decline in liquidity. These would be due in the first quarter of the year when the demand for credit is typically low being the slack season.

We could expect some affirmative steps to be taken by the RBI depending on the evolving situation. This could be through OMOs or term repo auctions.

The credit policy combined with the Budget provides a lot of comfort on the growth prospects for the economy. The concern on inflation remains as it is often caused by extraneous factors that may beyond the control of policy makers.

The Budget quite aptly focuses on growth and the credit policy on inflation, which makes coordination quite seamless.