Next comes the monetary policy

Next comes the monetary policy

If one goes by the signal given by the Economic Survey and combines the same with the Budget indicative borrowing programme, it does appear that there is a strong case for RBI to hike rates one more time. After that there could be a long pause

Madan SabnavisUpdated: Saturday, February 04, 2023, 01:49 PM IST
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There have been several important economic announcements this week which will culminate with the MPC meeting on 6-8th of this month with the announcement of the credit policy. Normally a credit policy in February holds less interest as it is the last one of the financial year. The April policy is considered to be the more important one as it sets the tone for the coming year. This time the RBI’s call on interest rates will be keenly watched.

Let us go over the major events that have taken place. On the 31st of the month, the Economic Survey was presented. This is the view of the ministry on the state of the economy. The major part is on the past where data is already available, though the Survey details everything that has happened. It is more of a report card of progress made in various segments of the economy.

The interesting part is, however, the take on the future. Here the Survey gave numbers on GDP growth which has been taken at 6-6.8% with a baseline growth rate of 6.5%. This is significant mainly because most forecasters are looking at a number less than 5.5%. But the government is sure of this range and in a way goes along with the IMF which gave a forecast of 6.1% for the year. Any number above 6% sounds good while something lower raises a red flag. The takeaway is that while the world will enter a phase of slowdown, India will be decoupled to an extent. The Survey also points out to inflation coming down, though warns of interest rates remaining elevated. There is concern on the external account and currency. One can surmise that a depreciation is what is being looked at.

Next, came the Budget which was the big event of the year where the government presented the numbers. Yes, some tax slabs have been altered to make the individual happy though it may not mean much in absolute terms. There is additional spending on capex which is what everyone wanted. But one should be cautious in interpreting this number of Rs 10 lakh crore. While the government is doing its bit, the main thrust has to come from the private sector which has been lagging in this respect. So when statements are made that the government capex will crowd-in private investment, there can be some discomfort considering that this has not happened in the last 6-7 years.

However, the major area of concern was the fiscal deficit and as the government has decided to continue to tread the path of fiscal prudence, the ratio has been reduced to 5.9% of GDP for the year. The fiscal deficit is the total amount of borrowings which comes from the market as well as the small savings fund besides short-term borrowings. As a last resort there is some draw down of cash reserves. The comfort provided here is that the borrowing programme in net terms will be at Rs 11.8 lakh crore which is almost the same as that last year. This means that there will be less pressure on the system liquidity. This will be the point from where the RBI has to take the baton and react.

The same night of the Budget the Federal Reserve announced a hike of 25 bps this time taking the rate to a range of 4.5-4.75%. The commentary however suggests that there will no rate cut for sure this year and hence while the rate cuts may slowdown and stop as inflation has been trending downwards there is no chance of a reduction. This is something that the RBI will be listening to closely. Add to this the Bank of England on Thursday increased their rate by 50 bps to 4% though has indicated that it has ended the automatic raising of rates.

The question now is what will the MPC do? Inflation in India has been trending downwards and could average 5.3-5.4% this quarter. This is below 6% but higher than 5%. At times when we look at inflation the headline inflation is less important than the core inflation rate. This is above 6% (non-food non-fuel inflation). This being the case the threat of inflation is low but it may take some time before it goes below 5%. At the same time if the RBI is looking at real interest rates, it is presently at around 1% which can be acceptable. Therefore it will be a toss for a further hike in rate and a pause. The transmission has already been effective in terms of deposit and lending rates and banks have followed suit.

If one goes by the signal given by the Economic Survey and combines the same with the Budget indicative borrowing programme, it does appear that there is a strong case for RBI to hike rates one more time. After that there could be a long pause. This has been the signal given by other central banks too that when they stop raising rates they should take a breather to see how inflation plays out. Today the biggest risks to inflation is China. As China has opened it economy there will be a tendency for demand for goods to go up which will push up commodity prices. Crude oil has once again tended to be volatile.

The RBI policy announcement on 8th February will hence be watched by all the markets closely as they take cues from not just the stance but also language. RBI forecast of growth for next year will also be expected, though normally is provided in the April policy for sure.

Madan Sabnavis is Chief Economist, Bank of Baroda, and author of ‘Lockdown or economic destruction?’ Views are personal

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