Time to avoid the 'last hike'

Prior to the February Monetary Policy Committee (MPC) meeting, an overwhelmingly strong market consensus expected “one last hike” by the Reserve Bank of India (RBI). A very similar consensus of “one last hike” seems to be in place even before the April MPC meeting. However, one feels that arguments in favour of a pause in April are strong. Some of these arguments were flagged by the two MPC members, who voted against a rate hike even in February.

Admittedly, the last two monthly Consumer Price Index (CPI) prints were higher than expected. However, most forecasters, including the RBI, expect CPI inflation to soften to low- to mid-5 per cent levels for the larger part of 2023-24. Thus, the current repo rate of 6.5 per cent implies that India’s real policy rate will hover around 1 per cent during 2023-24, while maintaining a policy rate differential of about 1.5 per cent with the US.

While an elevated core CPI has been widely discussed, the core CPI average of 6.1 per cent during 2022-23 is only a tad higher than the average of 5.9 per cent during the previous two years. Inflationary pressures in India have been less severe compared with several other economies. For instance, US CPI averaged around 7.7 per cent during the last 12 months, markedly higher than an average of 3.4 per cent during the previous two years.

Till recently large trade and current account deficits had been major concerns for policymakers. However, the material narrowing of trade and current account gaps and range-bound INR should offer the RBI better comfort and cushion for pursuing a more “Fed-independent” monetary policy. While it is important for an emerging economy’s central bank to stay broadly in sync with the global interest rate cycle, one needs to recognise that the deviation in case of inflation and GDP growth from their respective trend lines in the Western hemisphere is much more pronounced than in India at the moment.

In the current EBLR (external benchmark lending rate) regime of immediate and fuller pass-through of policy rate hikes to lending rates, one expects the central bank to turn more nuanced after the 250-basis point repo rate hike in less than a year. A case in point is the home loan market. Home loans taken at, say, 7 per cent one year back will go to close to 10 per cent in case of another hike, leading to sharp hikes in either EMI (often by over 30 per cent) or loan tenor (by several years), causing significant pressure for a huge number of home buyers across segments.

Overall, the rate sensitivity of India’s retail inflation is often just moderate and rate hikes are not costless. Also, the RBI has hiked the effective policy rate by an unprecedented 325 basis points during 2022-23. It is now important for the RBI to leave the policy rate at a level which can be kept unchanged for a long time, as against hiking rates very aggressively today and building up pressure for cutting the same only in a few months.

I am, thus, in favour of a pause in April. However, if a majority of the MPC members still favour a hike, it will be prudent for the RBI to turn more accommodative on the liquidity front, say, via open market operation purchases.

Finally, one feels it is now time for the RBI to consider a Fed-like “dot plot” for the future path of the repo rate, which will mean better anchoring of market expectation of MPC action and thereby less uncertainties and disruption.

The author is the chief economist and head of research in Bandhan Bank. The author thanks Rahul Goenka for his assistance. Views are personal