Will we see a reverse repo hike this week?

Can RBI afford the luxury of waiting out on the inflation front to allow growth to pick up?

Many say the April 6-8 meeting of the Monetary Policy Committee (MPC), the rate-setting body of India’s central bank, will be its toughest since the outbreak of the Covid pandemic.

In its last meeting in February, just after the Union Budget, the MPC left the repo rate (at which the central bank infuses liquidity into the system) and the reverse repo rate (at which it sucks liquidity out) unchanged at 4 per cent and 3.35 per cent, respectively. It also committed to continue with the accommodative stance “as long as necessary to revive and sustain growth on a durable basis”.

While both the US Federal Reserve and Bank of England have started tightening policy, the Reserve Bank of India (RBI) took a different stance to secure growth in the world’s sixth largest economy. Besides, its outlook on inflation was benign. Assuming a normal monsoon, retail inflation outlook, one year down the line, was estimated at 4.2 per cent at that point. It projected average retail inflation at 4.5 per cent in FY23 — 4.9 per cent in the first quarter, 5 per cent in the second, 4 per cent in the third, and 4.2 per cent in the fourth, “with risks broadly balanced”.

Things have changed dramatically since then.

There’s a strong acknowledgment by the US Federal Reserve that inflation is a real threat and it has resolved to tackle it. The Fed raised its policy rate by 25 basis points (bps) in March, the first 

since late 2018. One bps is a hundredth of a percentage point. The probability of a front-loading rate hike — a 50 bps hike at the Fed’s May policy meeting is likely, followed by as many as four 25 bps hikes in the year — as Fed chairman Jerome Powell has said the central bank must move expeditiously to combat inflation.

The European Central Bank, in its March 10 meeting, reduced the timeframe to end its quantitative easing programme by a quarter. Later, it admitted that the growth and inflation forecast has been outdated due to the Russia-Ukraine war. At the March 10 meeting, it had estimated inflation at 5.1 per cent in 2022.

The Bank of England, which raised its policy rate by 25 bps to 75 bps on March 16, also feels that the rising inflation caused by the war could squeeze household incomes and pose a risk to financial stability. Bank of England Governor Andrew Bailey has recently said swings in commodity markets after Russia’s invasion of Ukraine posed a risk to financial stability and the challenges facing the world economy are bigger than after the global financial crisis. The “hit to real incomes in Britain from rising energy prices this year now looked likely to be greater than any single year during the 1970s!” 

The war ensures that the supply chain disruptions, which caused the rise in inflation initially, would persist. The geopolitical risks and the rise in prices of oil and other commodities are adding to the uncertainties. During the February MPC meeting, the Brent crude price was hovering around $90 dollar a barrel. It zoomed to $139 a barrel early March before falling to $103, in a volatile market.

Finally, as the threat of the pandemic recedes, high-frequency indicators such as PMI manufacturing and services and collection of GST, among others, are pointing at a slow return to the growth path for India even as private investment is yet to pick up.

If these are reasons for the RBI to take a close look at its accommodative monetary stance and continue with the historic low policy rates, there are equally strong counterarguments.

For instance, India’s exports rocked till recently but following the war and the global central banks’ tightening policy, the global growth is being marked down. It is bound to have a knock-on effect on our exports, while the cost of import will rise, thanks to the price of crude.

Consequently, the trade deficit will widen. It rose by $16 billion in the third quarter of FY22, led by a sharp jump in both oil and non-oil imports and India’s current account deficit widened to a 13-quarter high of 2.7 per cent. 

Also, growth in India is not on a firm footing as yet. The private final consumption expenditure, a proxy for demand, is lower in March 22 than March 20. This is probably why the RBI thinks inflation is not caused by demand and is an outcome of supply disruptions.

Indeed, retail inflation rose to an eight-month high of 6.07 per cent in February 2022, breaching the upper limit of the inflation band (4 per cent +/- 2 percentage points) for two successive months, but it is not comparable with most developed markets. For instance, US inflation is at its four-decade high and in the UK, inflation in February has been the highest since March 1992.

Finally, the RBI has been raising the rates by stealth and draining liquidity. The process had started well ahead of other central banks. The 3.35 per cent reverse repo rate is redundant as the money is drained through variable rate auctions, and the short-term rates have risen to close to 4 per cent.

Still, the question remains: How different can the RBI be from global central banks in its concerns for inflation? It will definitely have to recalibrate its inflation estimate. Even though it had projected 4.5 per cent average inflation for FY23 in February, the market estimate was around 5 per cent. Now, most analysts say it could be around 5.6 per cent or even more. Inflation in India is no more transient and the concerns are for real. Media reports suggest the government may delay the restructuring of the GST slabs on inflation worry.

Can the RBI afford the luxury of waiting out on the inflation front to allow growth to pick up?

Like an astute 

trapeze artiste, Governor Shaktikanta Das has been doing a rare balancing act. I will not be surprised if the RBI continues with its accommodative monetary stance for now. It will also ensure adequate liquidity in the system. After all, the RBI needs to oversee the government’s record Rs 14.31 trillion gross market borrowing in FY23. Around 60 per cent of this, or Rs 8.45 trillion, will be raised in the first half of the year. Can it afford to rock the boat when such a large government borrowing programme is staring it in the face?

Incidentally, the RBI has been conducting dollar sell-buy swaps, draining liquidity from the system. This can create space for buying bonds through open market operations under its G-Sec Acquisition Programme (G-SAP) to anchor the borrowing programme.

Still, the MPC can raise the reverse repo rate to shrink the corridor between repo and reverse repo while continuing with the accommodative stance. This will not ruffle the market much as it can be interpreted as formalisation of the short-term rate hike, which has already been done through variable rate reverse repo auctions.

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

To read his previous columns, please log on to www.bankerstrust.in 

Twitter: @TamalBandyo