Vijay Kumar Gaba

 “No brainer” or “mo’ brainer”

What should an investor make out of a situation - when the RBI governor makes a public statement, two weeks before a scheduled monetary policy committee (MPC) meeting, asserting that it’s “no brainer” to expect that the committee will hike rates in the meeting? Especially when this assertion comes a day after the government has taken some very effective fiscal measures to control inflation and less than 3 weeks after the RBI had announced an unscheduled rate hike.

To me, at first it sounded like a confident Central Banker in full control of the situation. He exuded confidence that (i) the external situation of India is strong and the RBI shall be able to manage the current account deficit (CAD) comfortably; (ii) the central government might not have to revise the fiscal deficit target projected in FY23BE since revenue collections are strong; (iii) there are clear signs of growth reviving as reflected in rise in imports despite higher prices and strong exports; and (iv) the RBI is in control of the yield curve and INR exchange rates.

However, on second thought, I feel that the RBI is perhaps as perplexed by the current economic situation (global and domestic) as anyone else. In fact the Governor himself admitted that the situation is volatile and dynamic. Till the February 2022 MPC meeting, the Committee assumed that the inflation is transient and there is no need to tighten the policy but the Russia-Ukraine war changed the dynamics and in April 2022 meeting it was decided to (i) withdraw accommodation; and (ii) hike the effective reverse repo rate by 40bps (that immediately lifted overnight rate by 40bps). Within one month the RBI made an unscheduled 40bps hike in Repo Rate, palpably to preempt INR exchange rate slide in view of the imminent US Fed Rate hike.

The question is when so many external variables, which are not under control of RBI, are operating at different levels, having unpredictable impact on the Indian economy, how could the RBI term a future policy decision “no brainer”?

The Governor admitted that for now inflation is top priority and not the growth. The government appears to be in full agreement with this stance of the RBI. The government has recently diverted Rs one trillion of capex (Road and Infrastructure) allocation towards price maintenance to calm fuel prices. The government has also raised export duties on steel and restricted the export of wheat. The government has also taken measures like hike in subsidies on LPG and fertilizers. Reportedly, the government is also considering limiting sugar exports. Higher cotton prices have reportedly hurt textile exports in the past few months. Recently, the government has also extended the free food scheme for 90million households by six months till September 2022.

Juxtaposing all these, I could deduct the following:

(a)   To control prices, the RBI and Government have decided to sacrifice growth. Higher rates may further delay the private investment recovery. This means the supply side constraints may continue to hinder the growth for longer than previously anticipated.

(b)   The measures taken by the government may hit exports and therefore widen the already worrying CAD.

(c)    The Forex reserves are already down by US$50bn in the past six months. Keeping yields lower and INR stable may require more USD selling by RBI, at a time when CAD is vulnerable. Obviously the external situation might not remain as comfortable as the Governor is asserting.

(d)   The primary factors driving the inflation, viz., extreme weather conditions; global supply chain bottlenecks; Russia-Ukraine war; and Sino-US tensions etc. are beyond the control of the RBI and might continue to put inflationary pressures on Indian economy. So it could very well mean marked stagflationary conditions for a wider section of the Indian economy.

In my view, we all lie in a flux and there is nothing which is “no brainer” at this point in time. The situation is too dynamic to predict anything with reasonable certainty.

Presently, there are two diametrical opposite views about the evolving global situation.

As per the first view, there are conspicuous signs of global growth slithering down as the inflation has begun to destroy the demand, except the food for which demand is largely inelastic. In the recent readings of composite leading indicators have expanded for only one fifth of the countries (vs over 90% in April 2022). PMIs for most developed countries are nearing July 2020 levels. The growth engine of the world, i.e., China is stuttering with the latest growth forecasts fading to 3.9 to 4.5%. The monetary tightening by a number of central bankers has already started to show some results. Consequently, the commodity prices have started to cool down and inflationary expectations should ease going forward. It is therefore likely that the present monetary tightening cycle may reverse much earlier than previously forecasted. This view thus assumes a broad status quo on the present global order.

The second view however assumes a radical shift in the global order. As per this view, the extant global order that is characterized by deflation, independent central banks, globalization, minimum government, rising share of corporate profits in GDP, longer cycles and lower volatility is coming to an end. The emerging global order is remarkably different. It shall be characterized by regionalization, larger socialist governments, pricing power with labor and commodity producers, lower corporate share in profit, high real rates and inflation and poor equity returns.

I am struggling to form a view that lies in between these two extremes.

(mo’ brainer (noun): A situation or puzzle or predicament that is more difficult than it at first seemed; the opposite of a "no brainer"; something that requires more than one person (i.e. mo' than one brain) to figure out.)