The Reserve Bank of India (RBI) governor declared victory for its policy stance in unambiguous terms while presenting the latest monetary policy statement. He stated, as a result of various policy measures taken by RBI since April 2022 “the real policy rate has been nudged into positive territory; the banking system has moved out of the Chakravyuh of excess liquidity; inflation is moderating; and economic growth continues to be resilient”.
MPC remains predictive – 25bps hike with stance unchanged
The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) in its meeting held over the past three days decided to hike the policy repo rate by 25bps to 6.75%. The decision was taken by a majority vote with four members voting in favour and two members voting against the hike. The MPC also maintained its monetary policy stance of withdrawal of accommodation with a split vote of 4 to 2.
The decision of the MPC and voting pattern is mostly in line with the consensus forecast. The equity market nonchalant post the predictable policy statement was made public; while bonds witnessed some sell-off.
Notwithstanding the stance of a divided MPC, the RBI moderated its inflation forecast for FY24 to 5.3% and enhanced their real GDP growth forecast for FY24 to 6.4%. The growth projected for 1QFY24 is 7.8%; which appears rather optimistic under the current circumstances. Even for the full year FY24 the market consensus is close to 6%.
Rate hike and tightening to break persistence of inflation
While acknowledging that global inflationary headwinds are subsiding; food inflation outlook is encouraging; CPI inflation for FY24 is expected to remain within RBI tolerance band of 4 to 6% throughout the year; and substantial reduction in surplus liquidity in the financial system - a majority of MPC decided to hike the policy rates and also to continue with withdrawal of accommodation, ostensibly to “break the persistence of core inflation”.
Growth remains resilient
Available data for Q3 and Q4:2022-23 indicate that economic activity in India remains resilient. Urban consumption demand has been firming up, driven by sustained recovery in discretionary spending;, and rural demand continues to show signs of improvement as tractor sales and two-wheeler sales expanded in December.
Investment activity continues to gain traction. Non-food bank credit expanded by 16.7 per cent (y-o-y) as on January 27, 2023. The total flow of resources to the commercial sector has increased by ₹20.8 lakh crore during 2022-23 so far as against ₹12.5 lakh crore a year ago.
On the supply side, agricultural activity remains strong with good rabi sowing, higher reservoir levels, good soil moisture, favourable winter temperature and comfortable availability of fertilisers.5 PMI manufacturing and PMI services remained in expansion at 55.4 and 57.2 respectively, in January 2023.
Growth outlook: Real GDP growth for 2023-24 is projected at 6.4 per cent with Q1 at 7.8 per cent; Q2 at 6.2 per cent; Q3 at 6.0 per cent; and Q4 at 5.8 per cent. The risks are evenly balanced. Key risks: Pprotracted geopolitical tensions, tightening global financial conditions and slowing external demand
Core inflation sticky
Headline CPI inflation moderated by 105 basis points during November-December 2022 from its level of 6.8 per cent in October 2022. Core CPI inflation (i.e., CPI excluding food and fuel), however, remained elevated.
Considerable uncertainties remain on the likely trajectory of global commodity prices, including price of crude oil. Commodity prices may remain firm with the easing of COVID-19 related restrictions in some parts of the world. The ongoing pass-through of input costs, especially in services, could keep core inflation at elevated levels. Fiscal consolidation and stable INR however are some positive factors for contained inflation.
Inflation forecast: Assuming an average crude oil price (Indian basket) of US$ 95 per barrel (present price US$78.5/bbl) and a normal monsoon, CPI inflation is projected at 5.3% for 2023-24, well within the RBI tolerance band of 4 to 6%.
External balance comfortable
The current account deficit (CAD) for the first half of 2022-23 stood at 3.3 percent of GDP. The situation has shown improvement in Q3:2022-23 as imports moderated in the wake of lower commodity prices, resulting in narrowing of the merchandise trade deficit.
The net balance under services and remittances are expected to remain in large surplus, partly offsetting the trade deficit. The CAD is expected to moderate in H2:2022-23 and remain eminently manageable and within the parameters of viability. On the financing side, net foreign direct investment (FDI) flows remain strong; and forex reserves have recovered to 9.4 months of import. India’s external debt ratios are low by international standards
Remittances to remain strong on buoyant IT Service and growth in gulf region
Global software and IT services spending is expected to remain strong in 2023. Remittance growth for India in H1 of 2022-23 was around 26 per cent – more than twice the World Bank’s projection for the year. This is likely to remain robust owing to better growth prospects of the Gulf countries.
Growth forecast and policy stance incongruent
The real growth forecast of 6.4% by RBI is by far the most optimistic. Most agencies have been working with close to 6% growth estimates. The forecast of RBI appear even more unbelievable if we consider that —
(i) The real rates are now mostly positive and close to the levels where these shall start hurting growth very soon. Given the current credit to deposit ratios for most of the banks, we shall soon witness the rates spiralling higher across the spectrum, further impacting the growth adversely.
(ii) The tighter liquidity in the system has already started hurting the credit growth. A further withdrawal will definitely constrict growth going forward.
Obviously, something gotta give – either this high growth target would remain elusive or the MPC will have to climb down and change its policy stance.
Governor invokes Gandhi and Subhash
To mark the 75th anniversary of nationalization of RBI, the governor invoked Gandhi and Bose.
“I do believe that…India…can make a lasting contribution to the peace and solid progress of the world.” — Mahatma Gandhi
“…never lose your faith in the destiny of India” —Neta Ji Subhash Chandra Bose.
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