Why RBI must front-load the forthcoming rate hikes 

 

The latest provisional estimates of GDP growth for FY22, of 8.7 per cent, has sent out multiple signals. Slightly lower than the earlier estimate of 8.9 per cent, the latest figure is evidence of the pressures which the economy felt on account of the third wave of the pandemic, and the Russia-Ukraine conflict in the fourth quarter of FY22. 

More worrying, of course, is the Q4FY22 growth figure of 4.1 per cent, particularly against the Q3FY22 figure of 5.4 per cent. And, in sum, the final GDP figure for FY22 is only 1.5 per cent above the FY20 (pre-pandemic) level. While there is cause for some cheer, given the huge hits the economy took between FY20 and FY22 thanks to the multiple waves of the pandemic, there is enough reason for caution. 

Slowing global growth, thanks to the withdrawal of the easy monetary policies by several central banks, together with rising domestic inflation presents a potentially dangerous cocktail for the Indian economy. Most economists also reckon that the elevated inflationary risks are bound to hit the pace of revival in consumption domestically, since inflation is increasingly becoming broad-based. 

The FY22 growth estimates show that while private final consumption expenditure (PFCE) and gross fixed capital formation (GFCF) were estimated to be higher, the worrying factor is PFCE is only marginally higher (1.4 per cent) than FY20 levels, and inflation is bound to pose a threat to this slow recovery in private consumption. 

Looking closer at the Q4 numbers, the PFCE figure shows a sharp slowdown in growth, to 1.8 per cent from 7.4 per cent in the previous quarter. Government final consumption expenditure and GFCF were up in Q4 as government capex spending continued. 

Two major positives may come to the rescue of the economy in FY23 despite the multiple risks and the continuing Russia-Ukraine conflict. As analytics major CRISIL’s chief economist Dharmakirti Joshi mentions, the forecast of a normal monsoon, and the growing momentum in contact-based services (as I pointed out in a previous edition of Vantage Point) could provide relief amidst the gloom. 

“There’s no time to wait and watch anymore,” Joshi tells me as we chat about the latest GDP figures. He says since inflation typically hits the poor the most, and energy and food prices remain elevated, both RBI and the government will need to keep a close watch on these aspects. The government, of late, has taken some steps to soften fuel prices by cutting duties and will have to keep a continuous watch on price levels.

The RBI, Joshi tells me, will need to front-load the next round of rate hikes to tackle inflation at the earliest. RBI, he says, should raise rates quickly now and then take a wait-and-watch stance to examine the effects unfolding. CRISIL, on its part, has maintained its 7.3 per cent growth projection for FY23, with risks tilted towards the downside. Joshi agrees that the services rebound will continue to be visible in the first quarter of FY23, and services will strongly power the overall growth figure for the quarter.  

Coming back to RBI and rates. The sharp rise in input prices owing to elevated commodity prices took its toll on the manufacturing sector in the fourth quarter, with the sector showing a contraction (-0.4 per cent year-on-year) versus a 0.3 per cent growth in the third quarter. Inflation, then, remains a clear and present danger. 

It is a given that RBI’s immediate focus will remain on prioritising inflation over growth. Governor Shaktikanta Das has also said that a rate hike in June was a “no brainer”, and the debate is now on the quantum of the rate hike which the RBI will announce on June 8, when the next meeting of the Monetary Policy Committee ends and the policy statement is announced. 

Most economists reckon there will be a 50 basis points (bps) hike in the benchmark repo rate on June 8, after the off-cycle, surprise 40 bps hike on May 4, when a 50 bps CRR hike was also announced. Barclays India MD & Chief Economist Rahul Bajoria, for instance, feels a 50 bps hike in June will likely be followed up with another 25 bps in August. 

As Joshi points out, there’s still enough headroom for RBI to hike the repo rate and bring it up to the pre-pandemic level of 5.15 per cent. Bajoria, therefore, reckons these two rate hikes in June and August will serve to bring the repo rate to its pre-pandemic level in quick tightening moves. A Reuters poll of economists has also shown similar results, where respondents said they expected rate hikes of at least 100 bps over the next four policy meetings. 

The key for RBI, then, is to tackle inflation as quickly as possible for maximum impact as global headwinds show little signs of abating. Inflation is the single-biggest threat to the economy, and the corporate sector has factored in rate hikes for now. The rate hikes would begin affecting the corporate sector by the fourth quarter of the current fiscal, but for now RBI can do little else other than focus on inflation. Governor Das, who has navigated monetary policy ably during the peak of the pandemic, will have to be quick on the draw this time around. All eyes will be on what he says on June 8. 

The author is Editor, Business Today.

Also read: Is there more pain for investors or a pullback rally in June?