The unanimous 50bps hike in the repo rate recently by the Monetary Policy Committee (MPC) and a sharp upward revision in the inflation forecast, depicted continued urgency on policy catch-up amid the MPC’s reassessment of the inflation outlook, said Emkay Global Financial Services in a report.
The minutes also indicated the rate trajectory ahead.
The RBI released the minutes of the MPC meeting held during June 6-8, 2022 on Wednesday.
According to Emkay Global, the broadening of inflation pressures and generalisation and persistence of inflation made most members uncomfortable, even though some reckoned the largely imported nature of the current inflation.
“Most members believed that, amid fears of second-round effects on estimates, an early hike was necessary to avoid any unintended economic shocks,” Emkay Global said.
The minutes also gave cues on the rate trajectory ahead. While all reckoned rates needed to go up further, there was still divergence on the possible terminal rate, the report said.
Prof Jayant Varma believed that the RBI MPC, like most leading central banks, should also provide a dot plot to signal its future rate projections, which will help in anchoring long-term bond markets and inflation expectations.
Dr Michael Debabrata Patra argued that the repo rate needs to be increased to at least as high as the one-year-ahead inflation forecast suggests (near zero), knowing that monetary policy works with lags.
According to Dr Ashima Goyal, the current stage of recovery, the one-year ahead real rate must not fall below -1 per cent, Emkay Global said.
Some members see a need for demand compression but recommend moving with caution
Emkay Global said there were signs of caution in terms of aggressive policy tightening. Dr. Patra suggested that current inflation is predominantly a supply-side issue, and as a consequence, for monetary policy, rather than materially compressing demand, managing expectations is the key.
Dr Goyal argued that, unlike the West, India’s inflation is yet neither demand-driven nor seeing a wage-price spiral. Labour markets are not tight and wage increases are not universal yet across rural and urban sectors.
Meanwhile, the credit offtake is still modest – broad money growth at 8.8 per cent was much lower than nominal income growth.
Dr Ranjan suggested continued monetary-fiscal coordination to anchor inflation expectations while RBI Governor Shaktikanta Das stated that the second-round effect of adverse supply shocks is what they are targeting.
According to Emkay Global, the triple whammy of commodity price shocks, supply-chain shocks and resilient growth has shifted the reaction function in favor of inflation containment.
The inflation prints of the next two quarters are likely to exceed seven per cent, which could pressure the RBI into acting sooner rather than later.
FY23 could, thus, see rates go up further by 75bps plus, with the RBI now showing its intent to keep real rates neutral or higher to quickly reach pre-Covid levels, it said.
As per Emkay Global, a maximum tightening of the policy rate by six per cent by FY23, of which liquidity tightening to two per cent of net demand and time liabilities (NDTL) is tantamount to another estimated 25bps effective rate hike.
However, the front-loaded rate hike cycle does not imply a lengthy tightening cycle, and once they reach the supposed neutral pre-Covid monetary conditions, the bar for further tightening may go higher incrementally amid increasing growth inflation trade-offs, Emkay Global said.