“Persistence of high inflation necessitates further calibrated withdrawal of monetary accommodation to restrain broadening of price pressures, anchor inflation expectations and contain the second-round effects,” governor Shaktikanta Das said on Friday, following the September 28-30 review by the RBI monetary policy committee (MPC). “There is nervousness in financial markets with potential consequences for the real economy and financial stability. The global economy is in the eye of a new storm.”
The repo rate now stands 50 basis points higher at 5.9%, with other rates going up by the same magnitude. An ET poll of economists and investors had pegged the rate increase at 50 bps. Retail inflation is hovering at a multi-year high, having touched 7% in August and likely to have accelerated further in September. That could trigger a clause in the RBI Act that requires the central bank to spell out its strategy to bring inflation down to its target of 4%, with a tolerance band of two percentage points on either side. The MPC may meet off-cycle to finalise its reasoning to the government. To be sure, the central bank expects inflation to trend down and be within its mandated range over the next two years.
Dissenting Views on Rate, Stance
The six-member MPC witnessed a dissent on the rate as well as the monetary stance, which is focussed on withdrawal of accommodation. While five voted for the half point raise, external member Ashima Goyal was for 35 basis points.
Five members “voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Prof Jayanth R Varma voted against this part of the resolution,” the RBI said in its statement, without elaborating.
The RBI’s policy stance signals that more rate increases and a further withdrawal of liquidity are likely, said Aurodeep Nandi, economist at Nomura Securities.
“A higher US terminal Fed funds rate, 5.25-5.50% by March, and a weak currency, USD/INR at 85 by November, does add some upside risks to our forecast,” he said. “Therefore, we are raising our terminal rate to 6.50% from 6.15%.”
Investors gave a thumbs up with the Sensex climbing nearly 2% to 57,506.45 and the rupee gaining 0.6% to end at 81.37 to the dollar. Yields on the benchmark bond were a tad higher at 7.35%.
Central banks across the world are sending divergent signals with the Bank of England taking U-turn in monetary tightening after long-term yields spiked astronomically. It began buying government bonds against its earlier plans to sell them. The US Federal Reserve, which was expected to signal easing, stuck to its stance of a steep 75 basis point increase as it vowed not to repeat past mistakes of turning complacent on price pressures.
“The third major shock (quantitative tightening by developed central banks) has further accentuated the overall situation in the global financial markets and has its impact on creating excessive volatility in currency markets,” said governor Das. “Currencies are depreciating, financial markets are seeing excessive volatilities. Our bond yields have moved in a very orderly manner but world over bond yields have been very volatile so the third shock as you see has added to the already heightened uncertainty.”
Das said the widening current account deficit (CAD), which touched a decadal high in the June quarter, is not necessarily a cause of worry and the RBI would ensure smooth functioning of the currency market with its foreign exchange reserves, which have already declined about $100 billion as assets have depreciated in value and dollar sales to shore up the rupee.
“We remain confident of meeting our external financing requirements comfortably,” said Das. “Debt service ratio also indicates lower vulnerability as compared with most other major EMEs (emerging market economies). In fact, India’s external debt to GDP ratio is the lowest among major EMEs.”
Growth, Inflation
The central bank lowered its FY23 growth forecast to 7.0% from 7.2% earlier.
“According to the RBI’s surveys, consumer outlook remains stable and firms in manufacturing, services and infrastructure sectors are optimistic about demand conditions and sales prospects,” it said. “On the other hand, headwinds from geopolitical tensions, tightening global financial conditions and the slowing external demand pose downside risks to net exports and hence to India’s GDP outlook. Taking all these factors into consideration, real GDP growth for 2022-23 is projected at 7.0% with Q2 at 6.3%; Q3 at 4.6%; and Q4 at 4.6%, and risks broadly balanced.”
It maintained the inflation projection for FY23 at 6.7% (Q2 at 7.1%; Q3 at 6.5%; and Q4 at 5.8%). Consumer price index (CPI) inflation for the first quarter of FY24 is projected at 5.0%, it said.
Current Account Deficit
CAD for the June quarter was at $23.9 billion or 2.8% of GDP, the highest since the 2012 December quarter. It has deteriorated from a surplus of $6.6 billion a year earlier.
