The commodities pack, including crude oil, has witnessed reasonable respite. However, we are not out of the woods yet, as India remains heavily dependent on crude oil imports, apart from gold and electronics as our top three import items. Also, RBI cannot ignore the US Federal Reserve, which is driving in top gear as far as monetary tightening is concerned —and rightly so, as US CPI is at a four-decade high of over 9%. The recent Fed funds rate hike of 75 basis points seems a step in that direction. The Fed also seems quite focused on getting inflation back to target.
To be fair, inflation in India is reasonably well-behaved. Consumer price index based inflation in Q1 FY23 averaged at 7.3%, below RBI’s forecast of 7.5%. In July so far, most food items have fared relatively better than in June. In fact, TOP (tomato-onion-potato) prices have only marginally increased in July compared with an approximate 11% increase in June. Going by this trend, we may see Q2 average inflation also undershooting RBIs forecast of 7.4%.
Well, if things look good so far on inflation, is there merit in RBI wanting to hit the pause button for now? Not really. As stated earlier, the US Fed seems to be on front-foot with the pace of rate hikes. That means renewed strength for the US dollar ($). The dollar has been standing tall against most emerging and developed market currencies, including the Indian rupee ( ₹) which has seen approximately 5.8% depreciation FY23. The euro has depreciated approximately 8.3%, while sterling pound has depreciated approximately 8%. It is important to ensure a stable bias on the rupee, especially when our foreign exchange reserves are also receding. Hence, it is imperative that India continues to do the rate hike act for some more time.
How much rate hike is likely?
If we look at the market, (interest rate swap curve) it is already discounting at least 50 bps rate hike in every policy. In the June MPC minutes, RBI deputy governor Michael Patra said, “The objective should be to take the repo rate to a height that is at least above the four quarters ahead forecast of inflation, knowing that monetary policy works with lags." The Q4FY23 forecast for CPI is 5.80%. Hence, we may have to get to at least 6% repo rate by March 2023, unless crude oil has a sharp fall.
While the inflation-vigilant hat is active, the RBI also needs to be conscious of dwindling growth worldwide. IMF has recently downgraded its forecast for global GDP growth. Now, it expects the global economy to grow 3.2% in CY22 and 2.9% in CY23, down 0.4% and 0.7% respectively from its previous forecast.
Thus, it is fair to assume that the rate hike may not be accompanied by any hawkish undertone. Our base case would be to see a 50 bps rate hike in repo, which currently at 4.9%. However, it also quite possible that it could be a tad lower at 35 bps too. Multiple scenarios are possible, but we are of the view that RBI need not really hit the panic button for now and maintain the pace displayed in past few policy meetings. Either way, markets have discounted the same and may not react negatively if rate hike is up to 50 bps. Anything above that could mean a nasty turn for yields, which are struggling to stay afloat. So, all eyes on the RBI MPC, the same way Arjuna in the epic Mahabharata had focus on the eye of the fish!
The author is chief investment officer (debt) & head products, Kotak Mahindra Asset Management Company. The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organization or the Kotak group.
