The drastic measures outlined in the Monetary Policy Committee’s December review make clear that the fight against inflation will continue.
Release Date – 12:45 AM, Thu – 12 December 22
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By: Dr K Srinivasa Rao
Hyderabad: The Reserve Bank of India (RBI) voted to raise the repo rate by 35 basis points to 6.25%, in line with peers in major economies. As a result, the Standing Deposit Facility (SDF) was reset to 6%, while the fixed-rate reverse repos were kept at 3.35%. The liquidity window marginal standing loan and bank rates were raised to 6.5%.
The impact would raise borrowing costs for banks and companies pegged to floating rates. Depositors will benefit as the interest rate curve shifts. The external benchmark lending rate linked to the repo rate will rise immediately, while the reset of the marginal cost of funds based on the lending rate that banks will have to do to protect their margins will take some time.
no surprises
The move is not surprising, except that repo rates may have hit highs too early and need to be paused sometime at the start of FY24, at which point inflation should return to the downtrend path (4%/-2%, between 2% and 6%). The last high repo rate was 6.5% in January 2019.
The dovish tone of rate hikes since May 4 and the central bank’s transparent communication reflect its determination not only to rein in inflation today, but also to ensure that looming spillover risks do not derail its weakening trajectory. Thus, while CPI inflation eased to 6.77% in October from a high of 7.79% in April 2022, the RBI is keen to counter a spike in core inflation (excluding food and energy), which could weaken growth momentum and bring pain to the economy. Millions of people are at the bottom of the pyramid.
Headline inflation (including food and energy) is expected to remain at 6.7% in FY2023, with some adjustments in 1QFY24 to be below the RBI target, given external risks and long-term uncertainties in global energy prices 6% cap, then 5%. But there are higher upside risks to this medium-term inflation outlook due to geopolitical tensions, financial market turbulence and a rising incidence of weather-related disruptions.
path to maturity
Potential for growth can be gauged from the RBI survey, with consumer confidence improving further. Manufacturing and infrastructure are optimistic about the business outlook. The services sector is also expected to expand activity. This is further evidenced by the fact that non-food bank credit increased by Rs 106 trillion compared to April-November 2022. 1.9 trillion last year. Total resource flow to business sector increased by Rs 147 trillion in FY23 (ended November) as compared to Rs 68 trillion in the same period in FY22. The government’s focus on capital expenditure and infrastructure investment may increase the potential growth of different industries.
The rise in the Purchasing Managers’ Index (PMI) broadened the path for economic recovery, evidence that growth in agriculture, services and manufacturing is firming up. It needs greater support from financial intermediaries to provide working capital to explore its potential. The RBI expects growth to be largely driven by private consumption and investment potential, where supply-side efficiency and timely access to resources will play a bigger role than input costs.
external sector
The current account deficit (CAD) is expected to widen to 3% of GDP in FY2023 as exports slow due to a slowdown in the host country’s economy. But foreign portfolio flows have resumed in recent months, recording positive growth of $11.8 billion from July to 5 December 2022, led by equity flows.
Notably, net foreign direct investment (FDI) flows also remained strong, rising to $22.7 billion in April-October 2022 from $21.3 billion in the same period last year, despite substantial headwinds in emerging markets from sharp U.S. rate hikes . west.
New External Commercial Borrowing (ECB) agreements of $8.6 billion have been signed as a result of measures announced by the Reserve Bank of India on July 6 to boost foreign exchange inflows. Reserves rose to $561.2 billion on Dec. 2 from $524.5 billion on Oct. 21, covering about nine months of projected imports in 2022-23. These underlying markers will come into play for growth in the future.
future tasks
The drastic measures outlined in the December MPC review clearly show that inflation control is the RBI’s top priority. Market players can take cues from the policy allocation that they need to develop business strategies to be able to operate amid rising input costs in the short term and save on borrowing to remain competitive.
Financial intermediaries, and more importantly banks, will provide support to the industrial and commercial sector by effectively recycling scarce deposit resources and optimizing asset-liability products. With liquidity pressures brewing, many banks are issuing specific bonds to fund their lending operations. Banks should work better with the lending community to speed up loan recovery and ensure fast loans to entrepreneurs to enhance their multiplier effect on GDP growth. More important than the cost of borrowing, timeliness matters to entrepreneurs.
In the long run, when the economy reaches its full potential to achieve its stated goal of entering the union of advanced economies in the coming decades, entities that consistently aim to improve operational efficiency may emerge as long-term winners. Near-term inflationary headwinds need to be addressed head-on to create the kind of buoyancy needed to guide growth.
(The author is an adjunct professor at the Institute of Insurance and Risk Management [IIRM], Hyderabad. personal opinion)
