Vijay Kumar Gaba

The Reserve Bank of India (RBI) made its last policy statement for the current fiscal year FY22. The statement is unambiguous on all four key issues:

1.    The inflation is likely to peak in the current quarter and fall to the RBI’s tolerance range from next quarter onward.

2.    The overall growth has recovered to the pre-pandemic level, but private consumption is lagging. The risks to the growth are on the downside and 2HFY23 growth should moderate to ~4.5%.

3.    The Monetary Policy Committee (MPC) is unanimously of the view that in view of the present growth vs inflation dynamics, there no case for a hike in the policy rates.

4.    The growth recovery is fragile and requires monetary policy support. Hence, MPC has decided to keep the policy stance accommodative by a majority vote of 5 to 1, as was the case in the previous two policy statements.

This accommodative stance of the RBI in total defiance of the global trend of monetary tightening led by inflation concerns is not surprising, given the fact that the RBI has been solely focused on growth for past 3years, since the incumbent governor has assumed the office.  In the post meeting press interaction also the governor and his deputy sounded calm, defiant and confident.

Obviously, the RBI knows much more than most of the market participants and commentators and is certainly in a much better position to decide the best course of action. From the policy statement and officials’ replies to the press it appears that RBI is relying significantly on (i) the outcome of the monetary tightening by global central bankers and consequent cooling down in global inflation; (ii) a favorable monsoon; and (iii) full success of government’s plan to catapult private capex and consequent pickup in private consumption. The RBI also appears to be assuming that “India’s inflation” is different from the “global inflation”, and it will ease without any monetary policy intervention.

The argumentative Indian in me is restless to explore between the lines and find what has not been said and what could wrong. I am sure a trader who takes the governor’s statement at face value and places his bets accordingly would make more money than someone doubting the words of the governor and taking a deep dive to explore the words that were not said.

Citing the first part of a verse from famous Shailendra song from Movie Guide raises suspicion whether the governor is gambling with Knightian Uncertainty. He only mentioned “Aaj phir jeene ki tammna hai (Today I wish to live again), signifying strong survival instinct. What he did not say was ‘Aaj phir marne ka irada hai (…even if I have to die for it today) signifying the willingness to take high risk.

Regardless, I would like to argue that the RBI is worried about—

·         A prolonged growth recession. 2HFY23 growth projection of below 5% is not in consonance with the projection made by the Economic Survey and professional forecasters.

·         Rise in cost of borrowing for government and consequent interest burden on the budget.

By completely side stepping the large borrowing program of the central government in the policy statement, the RBI has opened the doors to the speculation of a significant balance sheet expansion (QE in simple words). The reliance on foreign funds for financing the deficit is also seems high, implying that RBI is expecting the yield differential between developed market bonds and Indian bonds to remain attractive and also inclusion of Indian bonds in global indices.

The RBI has categorically accepted the subordinate role of monetary policy to the fiscal policy; though the statement claims “equality” of two policies.

Both the government and the RBI might be hoping and praying that Russia-Ukraine conflict is averted; US and China growth cools down and OPEC+ agrees to increase the oil production materially so that the global energy prices cool down materially. Else, the government may be forced to take the incremental fuel prices on its fiscal account, either by way of duty cuts or subsidy to the OMCs. This not only takes the BPCL disinvestment off from the table, but also brings a downgrade of India’s sovereign rating in the frame.

Notwithstanding, what the RBI statement reads, the inflation projection chart of the RBI is sufficient to raise suspicion. From 0 to 8% inflation range would render any forecasting method meaningless. It is reasonable to suspect that “hope” is one of the horses pulling the policy cart.

The steep yield curve that allows short term borrowing at 3.75-4% vs long term borrowing at 68% to 7% .This is obviously encouraging borrowers to borrow more through short term instruments. The risk of ALM mismatch that played havoc with non-bank lenders and real estate developers in recent past is thus increasing. By not doing anything to flatten the yield curve, the RBI perhaps has stretched its luck little too far.

Last but not the least, “staying put” is the best strategy when in doubt. The complete status quo in the RBI policy, when the things have changed so much since the last policy statement, signals a banker in doubt and not a confident policy maker as the governor has pretended to be.