38th MPC (September 28-30, 2022), Minutes released on October 14, 2022.
Resolution
-
Increase the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points to 5.90% (consequently, the standing deposit facility rate is adjusted to 5.65% and the marginal standing facility rate and the Bank Rate to 6.15%.)
-
The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth
Assessment of the Indian economy by the MPC
-
Real GDP grew year on year by 13.5% in Q1:2022-23 (lower than the RBI’s projection of 16.2% in the August meeting of the MPC).
-
Aggregate supply conditions are improving. Monsoon rainfall is 7% above average and its distribution will cover some deficit areas. This will boost agricultural activity.
-
Activity in industry and services is expanding, especially the latter, as reflected in PMI and other high frequency indicators. The IIP growth, however, slowed to 2.4% in July.
-
On the demand side, urban consumption is rising ahead of the festival season and rural demand is gradually improving. Investment demand is also gaining traction and merchandise exports posted a modest expansion in August.
-
CPI inflation rose to 7% in August 2022 from 6.7% in July as food inflation moved higher. Fuel inflation has moderated. Core CPI inflation remains sticky at heightened levels.
-
Overall system liquidity remained in surplus (based on LAF data); aggregate deposits of commercial banks grew by 9.5% and bank credit by 16.2% as on September 9, 2022.
Outlook by the MPC
-
Prospects for crop output are good and are buffered by adequate reserves, but the risk of crop damage from excessive/unseasonal rains remains. In such a case there could be elevated imported inflation pressures amplified by the USD appreciation.
-
Crude oil prices are uncertain and tethered to geopolitics. RBI’s enterprise surveys point to some easing of input cost and output price pressures across manufacturing, services and infrastructure firms; however, the pass-through to prices remains incomplete.
-
Taking into account these factors and an average crude oil price (Indian basket) of US$ 100 per barrel, inflation is projected at 6.7% in 2022-23, with Q2 at 7.1%; Q3 at 6.5%; and Q4 at 5.8%. CPI inflation for Q1:2023-24 is projected at 5%.
-
The improving outlook for agriculture and allied activities and rebound in services are boosting the prospects for aggregate supply.
-
The Government’s continued thrust on capex, improvement in capacity utilisation in manufacturing and pick-up in non-food credit should sustain the expansion in industrial activity that stalled in July.
-
As per RBI’s surveys, consumer outlook remains stable and firms in manufacturing, services and infrastructure sectors are optimistic about demand and sales prospects.
-
Geopolitical tensions, tightening global financial conditions and the slowing external demand pose downside risks to net exports and hence to India’s GDP outlook.
-
Taking all these into consideration, real GDP growth for 2022-23 is projected at 7% with Q2 at 6.3%; Q3 at 4.6%; and Q4 at 4.6%. For Q1:2023-24, it is projected at 7.2% .
-
Due to the lower estimates of GDP growth for Q1, there is uncertainty over sustaining the growth momentum needed to achieve growth of 7.2% for the full year, projected in the August MPC meeting.
Some important insights from the statements of the members of the MPC
Statement by Dr. Shashanka Bhide
In the case of vegetables, fruits, crude petroleum, petrol, diesel, LPG and electricity, the WPI increased at double digit rates in July and August. In the case of cereals, the increase was 9.8% in July and 11.8% in August. The impact of decline in international market prices on domestic prices is yet to pass through to the domestic consumer prices.
Statement by Dr. Ashima Goyal
Major advanced economy central banks overstimulated after Covid-19 and are over-reacting to inflation now, creating excess volatility in cross border flows to emerging markets (EMs). There are two mitigating factors for India, however.
-
First, after an initial extreme reaction, as commodity prices soften with a global slowdown, some of the investors who had left India because of its vulnerability to commodity inflation, will return.
-
Second, India still retains policy space for smoothing global shocks. Domestic demand can counter falling export demand.
However, the OECD points out that seasonally adjusted Indian quarter on quarter growth was the lowest after China and Poland. It is uncertain if domestic demand will sustain after the festival spike. RBI consumer surveys show 45% of households reported no increase in income levels compared to a year ago, this will definitely put pressure on aggregate demand.
On Repo Rate Cuts: Demand reduction has to contribute to lowering the current account deficit. The repo rate has to rise more. The question is whether the rise should be taken upfront or staggered over time?
In India, where lagged effects of monetary policy are large; harmful effects become clear too late and are difficult to reverse. Thus gradual data-based action reduces the probability of over-reaction. Taking Indian repo rates too high imposed heavy costs in 2011, 2014 and 2018.
The sacrifice of output from tightening is low if unemployment is low and there is excess demand. In India unemployment is high, it is just recovering from a series of global shocks and demand may be slowing already. If demand slows anyway, less tightening will be required.
Large hikes were required in India to reverse steep pandemic-time cuts. Since that is completed, going slow now will allow policy to be agile and data-based.
Most analysts are arguing for a 50 bps rise just to preserve a spread with US policy rates. This is a fear driven over-reaction. In the mid-2000s the spread was less than 150 bps and there were large capital inflows. In the past 2 years spreads of above 300 bps have not brought in debt flows. If the terminal Fed rate is 5%, will it require we raise ours to 8%? The carry trade is not a stable source of financing. India has earned enough independence to protect itself from policy errors of other nations.
In view of all these considerations, and to signal tapering of action, she voted for a 35 bps rise in the repo rate.
Statement by Prof. Jayanth R. Varma
We may be beginning to approach the terminal repo rate. A pause is needed after this hike because monetary policy acts with lags. It may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters.
If we raise the repo rate to around 6%, that would be a cumulative increase of around two percentage points in the space of just four months. The full magnitude of monetary tightening would be well over 250 basis points.
Much of the impact of this large monetary policy action is yet to be felt in the real economy. In fact, much of the policy rate action is yet to be transmitted to even the broader spectrum of interest rates. For example, less than a third of the increase in the repo rate during April-August has been transmitted to retail bank deposit rates. Bank deposit interest rates play a critical role in stimulating savings, dampening consumption demand, and thereby mitigating inflationary pressures.
Another interesting thing that he notes is that while it is true that in the past (notably in 1998 and in 2013), India has very successfully used interest rates to defend the currency. However, all these episodes were before the inception of an inflation targeting MPC in 2016.
The statutory mandate restricts the MPC to consider only two factors while setting interest rates - inflation and growth. It was a conscious legislative choice to let monetary policy be dictated by domestic economic considerations, and leave the external sector to be managed using other instruments. This means that the MPC cannot be guided by the effect of global monetary tightening on the interest rate differential.
Statement by Dr. Rajiv Ranjan
Economic activity is likely to sustain momentum with full fledged celebration of festivals after two years on the back of buffers of excess household savings, which will aid private consumption. Even though household’s financial savings have normalised from a peak level of 12.0% of GDP during 2020-21 to 8.3% in 2021-22, it is estimated that households still had an excess saving of around 7% of GDP at end-March 2022.
As consumption gathers traction and capacity utilisation surges beyond a threshold, this could fuel investment – the second engine of growth. India assuming the G-20 presidency in 2023 is likely to support economic activity with large infrastructure and tourism related investment.
Statement by Dr. Michael Debabrata Patra
The conduct of domestically oriented monetary policy is becoming hostage to unidirectional exchange market volatility and mobile capital flows seeking safe haven. Recession risks may be darkening the horizon, but more immediately, global macroeconomic and financial stability is under threat. No country is immune. Systemic central banks should pay heed to the possibility that today’s spillovers can become tomorrow’s spillbacks.
For net commodity importers like India, with over a third of the CPI being imported, a negative terms of trade shock convolutes macroeconomic management. As current account deficits widen and capital flows turn fickle, reserve depletions become not just sources of forex liquidity to a risk wrung market but also instruments of stabilising expectations – the RBI stands for stability.
Minimising volatility in the exchange rate becomes important from two points of view:
- limiting risks to financial stability from foreign exchange exposures and pressures on margins of corporations; and
- ensuring orderly functioning of financial markets so that volatility does not translate into financial stability risks. Accumulations during happier times have proved to be prudent.