By Churchil Bhatt
In contrast to the surprise inter-meeting rate action last month, today’s Monetary Policy Committee (MPC) outcome was broadly in line with market expectations. The MPC hiked the policy rates by 50 basis points (bps) and remains committed to withdrawal of policy accommodation. While the RBI refrained from hiking the CRR this time, it will continue to normalize excess system liquidity in a calibrated manner. Given the build-up in price pressures, the RBI revised FY23 average inflation higher by 100 bps to 6.7% while keeping the FY23 GDP growth projection unchanged at 7.2%.
The MPC sees future inflation risks broadly balanced after the massive upward revision to its forecast. While the committee acknowledged that the government’s recent excise duty cut and other measures should help abate price pressures, this support to inflation comes at a fiscal cost. Hence the government will have to either borrow more or spend less in order to lower inflation. But then again, the impact of government measures on inflation is immediate, while the ensuing fiscal cost comes with a lag. On the contrary to the same, RBI’s front-loaded rate hikes will take months to yield the desired effect.
Interestingly, Inflation, while a monetary phenomenon, also has a large psychological component. This behavioural aspect of inflation needs to be addressed as much as the monetary aspect. In addition to its action, MPC’s communication is an often used tool to influence inflation expectations. To that effect, MPC communication this time around is characterized by one key modification, i.e. the committee has purposely avoided specific forward guidance in relation to future action. In a sense, this is a reflection of how volatile the geopolitical and economic landscapes have become.
We live in an era characterized by high volatility and sheer unpredictability. As prices remain uncomfortably high and the pace of central bank tightening accelerates, global economic growth is expected to moderate. At the same time, inflation is expected to come off from very high levels to somewhat lower but still higher than desirable levels. Financial markets may, rightly or wrongly, perceive this slowdown in growth as a pre-cursor to recession and may view this trifling fall in inflation as the end of high inflation.
Regardless of the eventual outcome, we expect to see a lot of noise around growth and inflation over the next few months. However, extrapolation of early data may not be the right way to judge a fast changing world. In our view, there is still time before we can conclude whether the impeding growth slowdown will turn into a recession. Similarly, inflation falling from the peak may not be evidence of its demise.
In spite of all the uncertainty, bond markets are currently pricing another no-brainer rate hike of 35-50 bps in the August policy. The path thereafter will most likely be characterized by measured policy tightening, the extent of which will be determined by the then growth-inflation dynamics. Presently bond markets are factoring in the end state policy rate between 5.50%-6% by March 2023. Unlike markets, RBI doesn’t want to commit to any forward policy trajectory just yet.
Wiser now, RBI would like to keep its policy options open for any eventuality in this age of turbulence. Indistinct communication and the absence of explicit forward guidance can be a useful central banking strategy during such times. In a lighter vein, the situation is reminiscent of the following statement by Ex-Fed Chairman, Alan Greenspan – “Since I’ve become a central banker, I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said”. Need we say more!
(The author is the Executive Vice President Debt Investments of Kotak Mahindra Life Insurance Company. The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organisation or the Kotak Group. The views expressed do not reflect the official position or policy of FinancialExpress.com.)