👍👍👍A ‘dovish’ hike likely | The Financial Express

Clipped from: https://www.financialexpress.com/opinion/a-dovish-hike-likely/3032268/

It will be difficult for RBI to justify a pause in rate hikes based on incoming activity data—expect a 25-bps hike with a change in stance

The March RBI Bulletin has mentioned that their Nowcasting model predicts the fourth quarter FY23 GDP growth to be 5.3%, which is higher than earlier envisaged. In fact, there is a hint of an upside bias to their FY24 GDP growth forecast of 6.4% too. (IE)

RBI’s April Monetary Policy Committee meeting (decision to be announced on 6th April) has the interesting backdrop of divergent global and domestic developments. There are multiple options in front of the MPC as both the rate decision and the stance will be up for debate. Not only is the macro backdrop uneven, the MPC’s decision will be influenced by the lagged effect of more than 300bps of effective rate hike in a year’s time. The subjectivity in the policy choice is generally larger when we are approaching the peak of the rate hiking cycle. A dovish hike of 25bps can be expected from the RBI April policy meeting as the stance is likely to be changed from “withdrawal of accommodation” to “neutral”.

The most obvious question is why the rate hike now? While the markets could fret over the narrative of a growth slowdown later in the year, RBI is not yet indicating such a possibility. The March RBI Bulletin has mentioned that their Nowcasting model predicts the fourth quarter FY23 GDP growth to be 5.3%, which is higher than earlier envisaged. In fact, there is a hint of an upside bias to their FY24 GDP growth forecast of 6.4% too. There has not been any significant worsening in Citibank’s Growth Heatmap, although some of the company commentary around consumer durable demand has been more cautious. It will be difficult for RBI to justify a pause in their rate hikes based on incoming activity data.

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Recent inflation surprises, stickiness of core, and no visibility of the 4% medium term target imply that a premature pause could be affecting RBI’s inflation fighting credibility at a time when growth momentum is mostly intact. January and February 2023 CPI prints have surprised on the upside, which can lead to average CPI for fourth quarter FY23 to be higher than 6%, which will be 30-40bps above RBI’s own forecast in February’s policy. Demand side pressures are visible on core inflation as the pace of moderation in core CPI momentum is still very small, partly because of wage growth sustaining at a high level. Urban formal sector wage growth was anyway in double digits, but now, even rural wage growth momentum has picked up. The incomplete pass-through of falling input prices to output prices, improving supply chain dynamics and stable commodity prices could make RBI more comfortable about a softening of CPI momentum. However, weather related shocks—the February heatwave, March unseasonal rains and El Nino—could keep the risks around food inflation much elevated. On top of it, the lagged effect of electricity tariff hikes and possible impact of OPEC production cuts could make the MPC more cautious on inflation. RBI might not have enough justification to lower its FY24 CPI forecast of 5.3%, though it will be interesting to see whether the fourth quarter FY24 forecast is brought down on the back of a more favourable base now.

Global markets have witnessed disruptive events and significant volatility in the period after the February policy meeting. Citi global economists continue to expect in the baseline scenario that the banking stress will subside gradually but unevenly through the spring and have not altered much the 2023 global growth forecast of 2.2%. Citi’s terminal Fed rate forecast remains at 5.5-5.75%. Also, most of the global central banks have delivered on expected rate hikes despite the financial market turmoil. While uncertainty around the global economic outlook has increased, it will be challenging for RBI to proactively counter that risk through a “pause” in April when the situation is still very fluid. Unfortunately, monetary policy might have to be more reactive, picking up the pieces in case the negative shock is acute. Delivering on a small hike in repo rate now might actually signal that the Indian financial system is not suffering from any contagion or stress and hence there is no need to specifically focus on the financial stability objective through rates.

On the other hand, a change in stance to neutral from withdrawal of accommodation is warranted as almost the entire Covid-time monetary stimulus has been withdrawn now. Above 100bps real policy rate, weighted average call rate approaching the repo rate as a sign of operating procedure normalisation, durable liquidity in the banking system returning to pre-Covid level and operational flexibility to respond to any sharp rise in bond yields justify a change in stance to neutral. However, it is possible that RBI removes the phrase “withdrawal of accommodation” but not go all the way to neutral through coining an intermediate phrase.

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A 25bps repo rate hike along with a change in stance to neutral will likely be considered as a “dovish hike” as the markets will interpret it to be the last rate hike for now. RBI is also expected to opt for a longish pause after the April meeting as the base effect led fall in headline inflation over the next two prints allows them to assess the moderation in core inflation momentum and the impact of weather-related disturbances on food prices. The most plausible alternate scenario is of a “hawkish pause” where the MPC decides to leave both the rates and stance unchanged, keeping the option of future rate hikes more alive. The argument for this scenario could be from a risk management perspective to not rock the boat at a time when the global developments and its repercussions are difficult to assess and RBI’s need to “follow the Fed” is much lower now with the CAD well below the critical threshold. In case of a “hawkish hike” scenario of continuing the withdrawal of accommodation stance, markets will have to significantly reassess the terminal rate in this cycle and future rate cut expectations as it will demonstrate a different level of urgency to reach the medium-term CPI target of 4%.

The writer is MD and chief economist, India Citi Research, Citigroup Global Markets India