A 35-basis-point rate increase could be par for the course

This will take the policy rate to 6.25% and the RBI can continue with an open-ended statement, refraining from sounding dovish

Expectations of yet another rate hike next week are a no-brainer. The speculations ahead of the December meeting of the Indian central bank’s rate-setting body, the Monetary Policy Committee (MPC), are on the quantum of the rate hike.
 

Will the MPC continue the pace of hike with another giant step of 50 basis points (bps)? Will it go for the baby step of a 25-bps rate hike, for a change? Or, will it settle for the golden middle way — a 35-bps hike to take the policy rate to 6.25 per cent?

Since May, the Reserve Bank of India (RBI) has raised the repo rate — the rate at which commercial banks borrow money from the central bank — by 190 bps in four stages, from 4 per cent to 5.9 per cent.
 

Like in the past, the MPC needs to juggle with three balls — inflation, growth and external environment. The jugglers know that it’s about throwing them in the air, picking them up as they drop, and then doing it again.
 

Let’s look at each of them closely and how they could influence the quantum of the rate hike.
 

Through the tightening cycle, the stance of the policy has been “withdrawal of accommodation, while supporting growth”. Most agencies have continuously been paring the growth estimates for the Indian economy even as it remains the fastest-growing among major economies.
 

The September quarter growth in gross domestic product (GDP) has been 6.3 per cent in real terms against 13.5 per cent in the June quarter. The comparable figure for the year-ago quarter was 8.4 per cent. The big worry is a 4.3 per cent decline in the manufacturing sector’s output; the mining sector, too, contracted 2.8 per cent. A 4.6 per cent growth in agriculture is a bright spot, but the decline in manufacturing and mining exposes the weakness in the industrial sector; it will impact new job creation.

Will India be able to achieve 7 per cent growth in FY23 as has been projected by the RBI? (The central bank pared the growth projection from 7.2 per cent to 7 per cent in October — 6.3 per cent for the September quarter and 4.6 per cent each for the last two quarters, with risks broadly balanced.)
 

The first half has recorded 9.7 per cent growth. It needs to grow at 4.3 per cent in the next two quarters to hit the 7-per cent mark.
 

It could do that or fall marginally behind. The RBI may not rush to pare its growth estimate next week but the concerns will certainly call for slowing the pace of the rate hike.
 

Despite the rising trade deficit and current account deficit, and the global slowdown, the threats from the external sector have receded to some extent. The softening of commodity prices, particularly that of crude, is a relief. The price of Indian basket crude was around $104 per barrel in the first half of the current financial year. The RBI has based its inflation projection assuming a price of $100 per barrel in the second half. The price has been hovering around $87 per barrel.
 

A year ago, it was $65.72. After hitting a high of $139.13 on March 7 after Russia invaded Ukraine, it did drop to $83.03 on November 29.
 

The dollar index, which rose to 114.78 by September-end, dropped to 104.37 on December 2. The rupee, which sunk to its lowest, 83.29 a dollar, on October 20, has been hovering around 81.25 a dollar after strengthening to breach the 81-mark at least twice, on November 14 and December 1.
 

The foreign money flow has resumed. India’s foreign exchange reserves, which dropped to $524.5 billion in the third week of October 2022 from their peak of $642 billion in September 2021, have risen to $550.1 billion on November 25.
 

The US Federal Reserve dialling down the expectations of stiff rate hikes marks the biggest change on the external turf. Speaking at the Brookings Institution think tank last week, his last public appearance before the Federal Open Market Committee meeting on December 13-14, Fed Chair Jerome Powell said it was time to slow the pace of interest rate hikes.

His comment sent the markets soaring. The Fed will slow down the pace of the 75-bps rate hike, which it has been doing since June to fight the four-decade high inflation.
 

The retail inflation in India eased to 6.77 per cent in October, from 7.41 per cent in September, driven down primarily by a drop in food and beverages inf­lation. The non-food, non-oil core in­flation continues to remain entren­ched at 6 per cent. With this, retail inflation has been above the higher end of the RBI’s flexible inflation target (4 per cent +/- 2 per cent) for 10 months in a row.
 

The RBI has estimated retail inflation at 6.5 per cent in the December quarter and 5.8 per cent in the March quarter. The inflation trajectory is likely to be in sync with its estimate for the third quarter but it could be above the RBI’s projection in the last quarter.
 

Simply put, the rate hike should continue even though slowing growth is a concern as the inflation genie has not yet been bottled.
 

Without being explicit, in the October policy, RBI Governor Shaktikanta Das referred to the negative real rate. In the not-so-distant past, when retail inflation was 3 per cent and expected to rise to 3.4-3.7 per cent, the policy rate was 5.75 per cent. Now, when inflation hovers around 7 per cent and is expected to be at least 6 per cent in the second half of the year, the policy rate cannot remain 5.9 per cent. It must move up.
 

Big banks are offering between 6.25 and 6.5 per cent interest on one-year deposits, far lower than the yield of one-year treasury bills. The last week’s cut-off at the auction for a one-year treasury bill was 6.8678 per cent. When did we see such a gap? What incentives do the savers have to keep money with banks?
 

Also, look at these figures. Since March, the Fed rate has risen from 0-0.25 per cent to 3.75-4 per cent.
 

How does the graph look for India? Even though the repo rate was 4 per cent till the first rate hike in May, the operational rate was 3.35 per cent — the reverse repo rate. In a system flush with liquidity, the rate at which the commercial banks keep money with the central bank becomes the operational rate. So, the rate has risen in India by 2.55 percentage points (from 3.35 per cent to 5.9 per cent), narrowing the differential between the Fed rate and RBI’s policy rate and queering the pitch for the currency.
 

While the Fed will raise it to 4.25-4.5 per cent mid-December, how much will the RBI hike its policy rate?
 

Till the Fed started talking about reducing the pace of rate hike, the terminal rate or the peak rate at which the RBI can rest was considered to be 6.75 per cent. Now, it is down to 6.25-6.5 per cent.
 

There are three choices before the RBI.
 

It can opt for a 50-bps hike, taking the policy rate to 6.35 per cent and signalling a long pause, if not the end of the tightening cycle.
 

It can also go easy and prefer a 25-bps hike for now and cross the river by feeling the stones.
 

I will not be surprised if the MPC chooses to err on the side of caution by hiking the rate 35 bps, taking it to 6.25 per cent and continuing with an open-ended statement, refraining from sounding dovish.
 

It’s too premature to call it a day on rate hikes. There could be a pause or even another 25-bps hike in the February policy, to be presented after the Union Budget, before we see the cycle ending.
 

The MPC should keep the options open. We can claim to be decoupled from the rest of the world, but a lot will depend on how the US Fed walks on the rate turf beyond December.

The writer, a consulting editor with Business Standard, is an author and senior advisor to Jana Small Finance Bank Ltd

His latest book: Pandemonium: The Great Indian Banking Story

To read his previous columns, please log on to https://bankerstrust.in

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