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By Madhavi Arora
The policy transition is likely to stay shallow, with focus on domestic dynamics over global ones. Amid ultra-elevated term premia, India’s current real rates look reasonable, given the present crosscurrents. This could give some leeway to the RBI’s reaction function to have policy flexibility. Other Asian CBs are also currently taking advantage of the orderly global adjustment of financial markets to the new realities and are thus focusing on domestic dynamics over global ones and RBI is no different. While fixed Reverse Repo normalisation may still commence in 1HFY23, policy repo rate hike will be tepid and easily pushed to 2HFY23, with RBI in an active wait-and-watch mode.
RBI sends stout dovish intent by keeping fixed reverse repo unchanged
The MPC kept the key rates unchanged unanimously and reiterated its accommodative stance with 5-1 spilt. We reckoned in our recent note “Will RBI budge to nudge yields? that even though a formal hike in fixed reverse repo rate (RRR) is more like a formality given VRRRs are currently above 3.9%, no change in the same could be used tactically by the RBI to send stout dovish intent. It seems the RBI gauged that markets need to be assuaged over material tightening of financial conditions ahead as global dynamics change and thus decided to stay put.
Inflation and growth forecast kept benign
The FY23 CPI inflation is projected modest at 4.5% in FY23 (Emkay: 5.1%); with unchanged estimates of 5.3% for FY22 and with risks broadly balanced. The RBI sees limited risks of pass-through of cost-push pressures into selling prices, keeping upside risks core inflation relatively low, amid subdued demand. The governor and deputy governor also stressed in the post-policy presser that material upside risks to inflation look low and compared sources of high inflation seen in the DM economies and India. The RBI seems less enthused about growth and expects real GDP growth in FY2023 to be at 7.8% (Eco survey: 8-8.5%). There may be positive impulses emanating from improving credit offtake, govt.’s capex push and easy financial conditions, but at this point economic activity is yet to be broad-based, and consumption is yet to reach the pre-COVID level. Global headwinds in the form of market volatility, supply-side disruptions etc. pose downside risk.
Slow normalisation ahead with policy rate hikes not commencing atleast before 2HFY23…
The stout policy signaling implies they would go slow on policy transition, even if it involves normalising the fixed RRR, which merely would have been a formality, as it is a marginal player in effective RRR estimation (3.87% currently). However, we think RRR normalisation may still be on the anvil ahead, (assuming orderly global rates transition) as the wide policy corridor is leading to high variance in the call money rate and call money/TREPS are still hugging the lower end of the corridor.
That said, we maintain our view that the RBI has some policy flexibility in hand which will delay repo rate hikes. Amid ultra-elevated term premia, India’s current real rates look reasonable vs. EMs, given the present crosscurrents. This could give some leeway to the RBI’s reaction function to conduct shallow normalization. While fixed Reverse Repo normalisation may still commence in 1HFY23, policy Repo rate hike will be shallow and easily pushed to 2HFY23, with RBI in an active wait-and-watch mode. We note other Asian CBs are also currently taking advantage of the orderly global adjustment of financial markets to the new realities and are thus focusing on domestic dynamics over global ones and RBI is no different. Bank Indonesia also kept policy unchanged today and showed no rush to hike ahead* in its guidance.
…but the journey of liquidity transition and possible return of OMOs/GSAPs will still be edgy
While we do not see policy Repo rate hike happening any sooner, the gradualist approach toward liquidity and rate normalization may be challenged by various global and domestic push-and-pull factors. Nonetheless, a huge bond supply in FY23 (even with upside surprise on tax revenues) will require the RBI’s invisible hand in a more visible fashion, implying return of a pre-committed GSAPs. The RBI may choose to neutralize that with CRR hikes, albeit it will face some communication challenges. The role longer tenor VRRRs as the preferred tools toward liquidity management will strengthen (with some changes and restoration of normal liquidity management framework), but the journey from current Rs6.5tn+ system liquidity to a pre-Covid normal of Rs 2tn+ is still going to be long-drawn. This implies unease with regard to the co-existence of liquidity/policy normalization, and accommodation is likely to persist. This also comes on the back of still-divided views on growth-inflation trade off.
Who bears the cost of fiscal/external sector dominance of monetary policy — Rates or FX markets? However, the macro adjustment owing to a change in global and domestic dynamics (US rates repricing, Brent surge, sharp FPI outflows, twin deficit, etc.) has so far been borne by the rates market, while the exchange rate market has been resilient. Though this risks a catch-up impact on the FX market in coming months, this could also imply the blowup in the rates market could ease. Medium term, the RBI may let exchange rate adjust to the new realities — letting it act as a natural stabilizer to policy reaction functions.
(Madhavi Arora is the Lead Economist at Emkay Global Institutional Equities desk. The views expressed are author’s own.)
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