Little scope for RBI to take its foot off the gas

How does one interpret a monetary policy statement that combines a relatively sanguine view on growth with an admission that inflation, particularly core inflation that nets out volatile components like food and fuel, is still a major concern? Going by the textbook, one would conclude that monetary tightening is not quite over yet or even likely to be over in the near future.

Thus, while the 35-basis-point (bp) hike announced in the policy on Wednesday was in line with market expectations, markets may have to wait before they exhale. More rate increases seem due and the terminal policy repo rate is likely to go up further, perhaps by another half a percentage point. This seems imperative if indeed the Reserve Bank of India (RBI) is serious about bringing consumer inflation below 6 per cent, the upper end of its target range, and then to the mid-point of 4 per cent. The RBI’s inflation forecast for the first quarter of 2023-24 is incidentally 5 per cent, which then rises to 5.4 per cent in the second quarter — anything close to 4 per cent is not even remotely in sight.

Over the past many months, the RBI has revealed a preference for orderly movements in the rupee. It has used its reserves to smooth out volatility, especially when there are strong depreciation pressures on the currency. Governor Shaktikanta Das’s continued emphasis on Wednesday on the factors that lend support to the rupee suggests that it has not changed its stand. Managing the currency is partly about managing interest rate differentials with other economies, particularly the US. The Federal Reserve (Fed) has indicated that while it might moderate the pace of rate hikes, it is far from done.

The RBI need not match the Fed one-to-one but there seems little scope to take its foot off the gas.

Monetary policy is not about interest rates alone. The RBI also controls the amount of money or liquidity in the system. Markets and banks should heed the governor’s advice to wean themselves off surplus liquidity. Banks are currently facing severe liquidity shortages as credit growth outstrips deposit growth by a mile. Were liquidity to tighten from its current average surplus levels of Rs 2 trillion, another round of deposit rate and lending rate hikes (banks will try to protect their margins) seem due.

What’s the bottom line then? First, the policy rate could move up further but the magnitude will be smaller, as Deputy Governor Michael Patra pointed out in the press conference, perhaps of a quarter of a percentage point. However, even if the RBI were to pause by the middle of 2023, the scope for cutting rates seem remote if a 4 per cent consumer inflation is indeed its goal. The RBI might not withdraw liquidity by the bucketful but average surpluses could be smaller, forcing banks to rethink their interest policy on deposits and interest rates.

A final word on the stance of monetary policy that remains ‘withdrawal of accommodation’. The RBI has offered a couple of versions in the past of how it defines its stance. If the stance is, going by one of the versions, determined by a level of the real interest rate, there is a chance that the February policy could see a shift to “neutral”. However, it all depends on how inflation behaves. The world of central banking has become entirely dependent on the flow of data. There are no guarantees there. 

The writer is chief economist and executive vice-president, HDFC Bank