RBI won’t go too restrictive; not more than 50bps hikes ahead: Madhavi Arora, lead economist of Emkay Global



Another front-loaded hike of 50bps reflects policy urgency with heightened global negative externalities. Clearly, the fast-evolving world order and consistent repricing of Fed’s outsized hikes has tied Emerging Markets’ hands, including that of the Reserve Bank of India (RBI). This exposes the instability inherent in the classic central bank trilemma and trade-offs. The broad narrative on inflation and growth remains unchanged, even as the growth forecast has been reduced by 20bps. External sector focus and INR moves/volatility seem to play on RBI’s mind, even though it doesn’t seem to be perturbed about any external financing and repayment risks.

The conscious front-loading gives the MPC some breather on shallow hikes ahead. The RBI is still far from its supposed real neutral rate of 0.8-1 percent, even as today’s hike makes the ex-post forward real repo rate positive. At this point, we still think that the RBI would not go too restrictive and the terminal rate could hover near the estimated neutral real rates, implying not more than 50bps hikes ahead. However, the extent of global disruption will remain key. We are closely watching the global pace of inflation deceleration and how the impending recession will shape Developed Markets’ central bank policies, which could influence the RBI. The still-fluid global situation might require frequent adjustments in macro and policy assessments ahead.

Global externalities weigh on MPC decision

The MPC expectedly raised the policy rate by another 50bps for the third consecutive time, with the repo rate now at 5.90 percent. The decision had a 5-1 split, with Prof. Goyal voting in favour of a 35bps hike. The supposed stance has been kept unchanged at “focus on withdrawal of accommodation”, albeit with consistent dissent from Prof. Verma. The broad underlying narrative is in line with our expectations: the world order is changing, and outsized US Fed hikes will lead the synchronized global monetary-tightening cycle. To that extent, global externalities and financial conditions override domestic dynamics. We had argued that the fast-evolving global dynamics and consistent repricing of the Fed’s massive hikes are strong-arming EMs, indirectly pressing their assets to offer higher risk premia to the world.

India has not been spared here, with concerns on the external front continuing to simmer despite easing global supply chain issues. The instability inherent with the classic EM central bank trilemma is exposed: one cannot have a stable currency, unfettered capital flows, and independent monetary policy all at the same time. This painful adjustment has also impacted RBI’s reaction function, which realised the net cost of a supposed soft signalling via a shallow hike could be higher than the explicit cost of a higher 50bps hike. Else, the avoidable noise in financial asset classes would have made the steady state equilibrium even more far-fetched.

INR and external debt pressures seem manageable

The Governor noted that INR weakness has been orderly and in the middle of the EM pack. He again asserted that INR is market-determined and predetermined by RBI, with the central bank only intervening to curb excessive volatility and anchor expectations. He also noted that of the near $ 70 bn loss in spot FX reserves FYTD23, about 67 percent loss is owing to valuation changes from surging USD and higher US bond yields. This, of course, does not include the rundown on forward positions. He also added that the umbrella of adequacy of forex reserves continues to be strong and external financing requirements will be met comfortably.

Inflation-growth outlook little changed

The broad narrative on inflation and growth remains unchanged. The tone on the inflation assessment was cautious; the press release again highlighted the risk that sustained high inflation could unmoor inflation expectations and lead to second round effects in the medium term. Even with mild easing in input cost of production, the inflation outlook is fraught with considerable uncertainty, given the volatile geopolitical situation, global financial market volatility and supply disruptions, while demand side resilience could also keep core inflation high. The inflation forecast has been kept unchanged at 6.7 percent for FY23 (Emkay: 6.5 percent). On the growth front, the sectoral value-add should be boosted by broad-based gains in agri, industrial and services sectors, while the demand side could be buoyed by rural and urban consumption in H2FY23. However, net exports could be a drag to growth. Keeping that into consideration, the RBI cut the growth forecast mildly to 7 percent with balanced risks (Emkay: 7.0 percent with downside risk).

RBI unlikely to go too restrictive

We think the conscious front-loading of policy rates gives the MPC some breather on shallow hikes ahead. With inflation likely to be largely in line with RBI’s estimates, today’s 50bps hike will make the ex-post forward real repo rate positive, albeit still lower than the RBI’s estimated real neutral rate of 0.8-1 percent. At this point, we still think that the RBI would not go too restrictive and terminal rate could hover near the estimated neutral real rates, implying no more than 50bps hikes ahead.

However, the extent of global disruption will remain key to the RBI’s reaction function ahead. The situation globally is still fluid, and macro assessments might require frequent adjustments from the policy perspective. With banking liquidity now closer to deficit levels, and comfortably below the threshold of 1.5 percent NDTL (which is seen as inflation-pressing), the policy focus will now also be on to transmission of past rate hike actions, in case of some calm in global asset classes.

The system liquidity may improve ahead only at the margin as government spending may be partly offset by higher currency in circulation and consistent high C/D ratios. This liquidity tightening also tantamount to another estimated 25bps+ of rate hike, implying less pressure on conventional repo hikes to take place.