The market’s view is that a rate hike is surely coming in October, given that inflation, even in October, will be above the upper threshold of the Monetary Policy Committee’s 2-6 percent range and even a year later, will be above the MPC’s mandated target of 4 percent. All told an excellent policy.
The RBI today delivered a strong half-a-percentage-point repo rate hike taking the rate to its highest since August 2019. With this, the RBI has raised the repo rate by 140 basis points in just 3 months (since May 4) — probably the fastest pace of hikes in decades — though much less than other central banks like the US Federal Reserve. The rate hike was clearly at the upper end of expectations, and led to bond yields jumping by over 15 basis points from its pre-policy level of 7.12 percent.
Today’s policy was noteworthy for some distinct changes in tone:
For the first time, the governor’s statement included detailed data on the external sector. It noted correctly the huge surge in imports and the expansion of the trade deficit to $100 billion in four months. It placated the market by pointing to robust IT services exports and also gave data on FDI and FII flows to prove that the current account deficit is being financed. This detailed dwelling on the external sector seems to indicate that the RBI preferred a 50 bps hike over 35 bps because of a need to show support for the rupee, even if the lip service to pure inflation-targeting is maintained.
2. The second seminal change in the policy document was the theme that growth has arrived. There were no references to “recovering” economy. In fact the governor rattled off a series of indicators like railway freight traffic, port freight traffic, e-way bills, toll collections, commercial vehicle sales, credit growth and rise in PMI to show that growth is robust. The most telling data he took pains to elaborate on was that the capacity utilisation in the manufacturing sector at 75.3 percent is now above its long-run average of 73.7 percent. It was plain that the RBI believes the output gap has closed, though to a question on whether he thought inflation is now being also pushed by demand, the governor stuck to the old rationale of supply-side issues. The final giveaway on growth was his statement that stability in growth has given RBI the space to hike rates and go after inflation.
3. A third important point to note is that the governor had previously said that the RBI’s inflation forecast of 6.7 percent for this year does not include gains from rate hikes. That phrase was conspicuous by its absence in the current policy, giving one the feeling thatthe RBI probably worries that inflation won’t fall all that much. The one-year ahead inflation forecast for the first quarter of the 2023-24 fiscal has hence been placed at 5 percent, despite a high year-ago base.
4. Finally, the RBI absolutely refused to be drawn into any guidance on when it will get to positive real rates — whether it will front-load or whether it is close to its neutral rate. The governor was firm, and rightly so, that there is too much uncertainty for such guidance.
The market’s view is that a rate hike is surely coming in October, given that inflation, even in October, will be above the upper threshold of the Monetary Policy Committee’s 2-6 percent range and even a year later, will be above the MPC’s mandated target of 4 percent. All told an excellent policy and appropriate accompanying statements — leaving the RBI room to move slowly or rapidly, depending on the global situation. Today’s round goes to the RBI!