Formulating a credit policy is always challenging as there is a need to balance various propositions. The most obvious one is the idea of inflation. Although it is lower at 4.7% in April and will likely remain so for the next few months, interpretations differ. Generally, one looks at core inflation, which has eased from 5.8% in March to 5.1% in April. But the inflationary explanation is fallible, and just as the concept of ‘core inflation’ emerged, another simulation could be reached. If vegetables and edible oils are excluded, the headline inflation rate would be higher at 6.2%. The issue here is that inflation is low due to two factors, for which prices are driven by non-moNetArya factor.
Another area that should also be looked at while targeting inflation is growth, which is more in line with the Keynesian school than the monetarist. In 2020 and 2021, the Reserve Bank of India (reserve Bank of India) took the view that it would do everything possible to maintain growth, which means it also has a purpose. The good news is that the latest gross domestic product (GDP) growth numbers at 7.2% prove that we are doing very well. The RBI now sees a GDP growth rate of 6.5% in 2023-24, which though low is impressive.
Beyond that, as noted in the governor’s statement, there appear to be many positives and few negatives for the economy. In short, growth will not be a risk factor this year, even though the quarterly trajectory will be on a declining trend from 8% in Q1 to 5.7% in Q4. This means that growth can be ignored from the monetary policy perspective at this point. In fact, the RBI is very optimistic on all three important elements of demand: rural consumption, urban income, and private investment,
However, a statistician would have a different way of looking at things, given that the inflation story is still a puzzle. Economic theory states that monetary policy operates with a lag, meaning that all actions taken now will bring down inflation in the future. But when will this materialize, given the current low numbers of vegetables and oils that are largely insulated from monetary policy action? Here, the governor has said that rate hikes of the past are still working their way through the system and further pressure on inflation will ease in the coming months.
With uncertainty due to El Nino effect on the Kharif crop, there is a looming risk to inflation, which has been acknowledged by the RBI. This has to be weighed against the fact that inflation is numerically below 5% and will remain so for this quarter. The RBI hasn’t really changed much in the inflation forecast trajectory for 2023-24, which stands at 5.1% for the year. But the statistical effect will see it lower in Q1 at 4.6%, after which it will move back to 5%-plus levels over the next three quarters with Q2 and Q3 getting progressively higher.
The problem with interpreting inflation numbers is that they are affected by base effects, where higher numbers in the previous year are lower in the year under measurement. This gives a feeling that inflation is coming down, although prices may still be high and may not decrease sequentially, as is the case for most products in the basket of goods considered for core inflation.
One can conclude that the next policy looks likely for another pause on rates as there will be no real surprise element in case inflation falls below 5%. Although the latter two quarters would see readings above 5%, a rate cut in Q3 may not materialize either, with inflation peaking at 5.4% before turning down in Q4. So the markets may have to wait for the fourth quarter for the first rate cut. Furthermore, it also appears that other central banks will not be in a rush to cut rates until there is more clarity on the inflation outlook.
The issue of attitude is also interesting. It is normally changed to neutral before a rate cut. But the current stance of withdrawing housing has been maintained, indicating two things. The first is that there is a lot of liquidity in the system, which the RBI is trying to drain through variable reverse repo rate auctions. This will continue till the level comes down to about 1% of net deposits and time liabilities. The second is that the difference between the repo rate and inflation is around 1.8%, which is the real rate. This number is probably acceptable to the RBI, and it may be satisfied with a margin of 1-1.5% in the long run. Hence, if inflation remains around 5%, as predicted by RBI, then markets can expect a rate cut of 25-50 bps in the medium term.
The timing, of course, will depend on when the RBI is convinced that the monsoon has advanced well and there is no risk of prices rising again. The increase in minimum support price announced yesterday is significant, and RBI will look at the impact on inflation. It will be known after September. The immediate market reaction was unchanged and hence the 10-year yield will remain stable around 7% as per RBI forecasts. But short-term returns can be more flexible depending on the liquidity conditions the exchange is currently comfortable with. 2000 notes.
The major takeaway from this policy, which has not changed any levers and only marginally changed the inflation forecast, is that now is not even the time to talk about timing, which has been the case with monetary policy recently. The matter has become a cliché, a pivot.
Madan Sabnavis is Chief Economist, Bank of Baroda and author of ‘Banking Trends and Controversies’
These are the personal views of the author.
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Updated: June 09, 2023, 02:37 PM IST