Monetary policy: Watchfully hawkish | The Financial Express

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The hawkish tone of the policy documents portends that if inflation does not fall in line with the MPC’s assessment for Q1 FY2024, another hike could be in the offing, especially if financial stability concerns recede.

monetary policy, rbi

The Monetary Policy Committee (MPC) unexpectedly paused in its first bi-monthly monetary policy meeting for FY2024, after having hiked rates by a substantial 250 bps through FY2023. The unanimous decision to pause on rates was quite surprising given the hawkish tone of most members in the minutes of the February 2023 meeting as well as the unpalatable CPI inflation prints for January-February 2023. Increased global financial stability risks amid developments in the banking sector in the US prompted the pause in the rate hike cycle, to assess the impact of the cumulative rate hikes on economic activity.

Nevertheless, the tone of the policy was clearly hawkish, with the document stressing on the need to ‘rein in the generalisation of price pressures and anchor inflation expectations’ as well as for low inflation to sustain the resilience in domestic economic activity. While the MPC highlighted that it would not hesitate to take further action as may be required in future meetings, the RBI Governor stressed that the current policy decision should be construed as a ‘pause and not a pivot’, implying that the door for further rate hikes remains wide open.

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While the MPC kept the first half of the stance—‘to remain focused on the withdrawal of accommodation’—unchanged, the formulation of the second half of the policy stance was modified. The latter stressed the need to ensure that ‘inflation progressively aligns with the target’ as against ‘inflation remains within the target going forward’. Interestingly, this prompted a change in the voting pattern on the stance, to 5:1 from 4:2 in the February 2023 meeting, with Ashima Goyal switching votes, while Jayanth R. Varma continued to express reservations even on the revised formulation.

The MPC pared its average CPI inflation projection for FY2024 marginally to 5.2% from 5.3% earlier. It raised its inflation projections for Q1 FY2024 by 10 bps to 5.1%, maintained the Q2 and Q3 FY2024 forecasts at 5.4% each, while cutting its Q4 FY2024 projection quite sharply to 5.2% from 5.6% earlier. It has now assumed an annual average crude oil price of $85 per barrel (Indian basket), lower than its earlier assumption of $95 per barrel, and a normal monsoon.

The committee has highlighted several risks to inflation, stemming from the impact of unseasonal rains and hailstorms in the recent period, continued elevated milk prices, uncertainty around the outlook for crude oil prices, increased global financial market volatility and its impact on imported inflation, and continued elevated core inflation amid the lagged passthrough of input costs.

While our projection of the average CPI inflation for FY2023, at 5.3%, is slightly higher than the MPC’s revised projections, we broadly concur with the MPC’s expected trajectory for inflation through the fiscal. Moreover, the downward revision in the Q4 FY2024 CPI projection to 5.2%, which is largely in line with our expectation of 5.1%, implies a real rate of ~130 bps which, we believe is adequate at the current juncture – this is likely to have supported the pause in today’s meeting.

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On the growth front, the MPC has surprisingly revised its real GDP growth projection for FY2024 to 6.5% from 6.4%, with a 10 bps upward revision in its Q3 and Q4 FY2024 projections to 6.1% and 5.9%, respectively, even as the Q1 and Q2 forecasts have been kept unchanged. The Committee has highlighted downside risks owing to protracted geopolitical tensions, tight global financial conditions and global financial market volatility.

ICRA expects India’s real GDP to grow by 6.0% in FY2024. While our H1 FY2024 GDP growth projections are quite similar to the MPC’s, those for H2 FY2024 differ materially. We expect GDP growth to slow to 4.5-5.0% in H2 FY2024, lower than our assessment of the potential GDP growth for the Indian economy.

The potential development of El Nino conditions poses significant risks to our inflation and growth forecasts for FY2024. If such a scenario materialises, it could hurt the prospects of crop output and rural demand, and put upward pressure on food inflation, even as seasonally healthy reservoir levels provide some insurance for the upcoming kharif season.

The hawkish tone of the policy documents portends that if inflation does not fall in line with the MPC’s assessment for Q1 FY2024, another hike could be in the offing, especially if financial stability concerns recede. Besides, we believe that the changed wording of the policy stance is intended to sharpen the focus on the 4% target for inflation, from the range of 2-6%, with inflation expected to print between 5-6% for most months of FY2024.

Owing to the unexpected pause, the yield on the 10-year Government security eased by 6-8 bps to 7.21% after the policy announcement. A further decline in the US 10Y treasury yields from the current levels could exert some intermittent downward pressure on the 10-year G-sec yield, although it is unlikely to trade below the 7.2% mark on a sustained basis. If the market expectations crystalise around another rate hike in mid-2023, then the 10 year G-sec yield could retest the 7.5% mark.

The writer is chief economist, head-research & outreach, ICRA

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