RBI's monetary policy to focus on macroeconomic stability

The Reserve Bank of India’s (RBI’s) monetary policy actions during April-May 2022 were swift and aggressive not just to control the surging inflation but also to safeguard the value of India’s domestic currency and to protect macroeconomic stability. In May, the US Federal Reserve had implemented its largest interest rate increase in two decades and like many other central banks. The RBI, too, had anticipated the Fed’s move and implemented its own monetary policy actions in an off-policy cycle meeting.

Reasons were obvious. While the economic recovery was too slow and uneven, India’s retail (CPI) inflation had stayed above the RBI’s upper tolerance level of 6 per cent for four consecutive months, driven by a broad-based increase in food, fuel and core inflation. Rupee-dollar exchange rate had developed a strong depreciation bias, triggered by the FPIs’ consistent outflows from both the equity and debt segments in the calendar 2022. In fact, on May 4 — the day RBI raised the repo rate by 40 basis points (bps) to 4.4 per cent and cash reserve ratio (CRR) by 50 bps to 4.5 per cent of NDTL, the rupee stabilised and appreciated from 76.57 to 76.41 per US dollar.

It needs to be highlighted that the RBI has been using all tools at its disposal to protect the nation’s macroeconomic stability amid the ongoing turbulence created by the global geopolitical situation and its spillover effects on the Indian economy. Besides using the tools of monetary tightening, the RBI has also been intervening in the foreign currency market to control rupee’s depreciation through futures, forwards (both onshore & offshore) and spot exchange rate markets. According to reports, it has sold dollars in the spot only to get in a buy/sell swap deal in the onshore forward contracts across maturities. This has freed RBI from delivering dollar stocks immediately after spot sales. On May 27, India’s foreign exchange reserves stood at a healthy level of $601 billion.

Since the last policy announcement, inflationary risks have increased significantly. Global Brent crude prices have gone up from $110 to $120 per barrel and domestic food prices have escalated due to the ongoing heatwave and shortages. The recent fiscal measures like duty cuts, export bans, etc., may not be much effective in controlling inflation amidst incomplete pass through of past cost pressures.

Rupee has further depreciated by 1.6 per cent since May 4. The US treasury yields have hardened on the back of a better-than-expected jobs report for May. Given this backdrop, we expect the RBI (MPC) to change its policy stance to “neutral” and raise the policy repo rate further by 35 to 40 bps at the June 8 meeting. We don’t expect it to raise the CRR this time as it has already sucked Rs 87,000 crore from the system and liquidity surplus has shrunk to Rs 3.64 trillion on June 4 from Rs 5.47 trillion on May 2. Moreover, a turn in the interest rate cycle has impacted the banks’ trading gains adversely.

A higher CRR will stress their profitability further, when they are expected to support growth via credit channels. The MPC will certainly revise upwards its inflation projection from 5.7 per cent for FY23 to 6 per cent-plus citing the elevated global commodity prices and rupee depreciation. It may even revisit its real GDP projection for FY23 against the backdrop of increased uncertainty in the global economic environment.

After the June 8 meeting, the RBI will strictly remain in a data-driven mode. It will closely follow the guidance of the major global central banks and quickly align its actions with theirs to avoid any knee-jerk reaction in the financial markets. However, until the shadow of uncertainty lingers, the RBI will not follow any “rule-book”. 

The writer is group chief economist, L&T Financial Services. Views are personal