Challenges of inflation, liquidity

Reserve Bank of India governor Shaktikanta Das’s utterance in May 2022 that the expectation of higher rates is a ‘no brainer’ holds good even for the September 30 policy announcement.

The Monetary Policy Committee (MPC) of the RBI will surely hike the repo rate, the rate at which the banks borrow from RBI, at least by 50 bps. It is now at 5.4 per cent. The money and the bond market, banks and HFCs have already factored the most likely rate hike by the MPC and raised their lending rates on housing loans, builder finance, corporate loans and loans to other critical sectors, much before the policy announcement.

The consumer price index inflation (CPI), which includes food and fuel, has been continuously rising since April 2022 and has been above the RBI’s upper tolerance limit of 6 per cent (4 +/- 2 per cent). The CPI inflation in April 2022 was 7.79 per cent, May 7.04 per cent, June 7.01 per cent, July 6.71 per cent and 7 per cent in August 2022. Even the core inflation (minus food and fuel) is at elevated levels in the present financial year, and is unlikely to cool down quickly. It will continue to suffocate the economy till March 2023. So, any rate hike lower than 30-40 bps will not tame inflation.

The global economic outlook has also not been kind to us. Developed economies (except Russia and China) are periodically and continuously hiking their interest rates, the latest being the US which raised policy rates last week steeply by an additional 75 bps—in the range of 3 per cent to 3.25 per cent. These rate hikes are creating panic in the Indian money market, resulting in flight of capital to US and other favourable destinations.

The portfolio outflow during FY23 till August 2022 has been a staggering $13.3 billion. Shockingly, from September 22 till September 26, the FPIs, who are fair weather friends, have pulled out Rs10,031 crore from the market. The increase in the repo rate will stem the ‘currency depreciation’ of our rupee against the US dollar. Our rupee has depreciated almost 10 per cent against the dollar since 2022, making imports costlier. The hike in the repo rate by the RBI in sync with rate hikes by the US Federal Reserve will also narrow the “interest differential” corridor. The present depreciation in the value of the rupee vs the US dollar will dent the GDP by a minimum 2 per cent. The gross financial savings of our households has dipped to 10.8 per cent of our GDP in FY 2022, falling from 15.9 per cent in FY2021, even when the GDP contracted, and 12 per cent each in the last three years. A higher repo rate will result in banks offering higher deposit rates to attract household savings into the banking system. This will also prevent people from investing in conspicuous consumption items such as gold and real estate. Demand curtailment is also one of the aims to contain inflation via rate hikes. The rise in interest rates will curtail economic growth in the near term. The growth shoots witnessed in sectors like agriculture, real estate, housing, infrastructure, and MSMEs, and the credit offtake by the banks to nearly 16.2 per cent as at September 9 year on year, will get stifled. This has to be borne as a necessary evil to curtail inflation by restricting spending and containing demand.

The last few interest rate hikes by the RBI have already dented industry growth. The Index of Industrial Production (IIP) has grown at an anaemic 2.4 per cent in July as against 12.7 per cent in June. The urban unemployment rate continues to be elevated in the range of 7 to 10 per cent. The rupee devaluation against the US dollar will widen the current account deficit to an alarming level. We import 85 per cent of our oil requirement, which is in-elastic. A similar situation exists when it comes to import of semiconductors.

Though theoretically, exports should be an attractive proposition at Rs 82 to the dollar, the present global scenario negates this proposition as most of the developing countries have already slipped into a recessionary mode, thus blocking our foreign exchange earnings. Our foreign exchange reserves have depleted to an “uncomfortable level” of $545.6 billion in September 2022 as against $643 billion a year ago. The RBI may issue some policy guidelines to curb imports of conspicuous consumption such as gold and luxury items and even levy additional ‘customs duties’ on such items and PLI schemes to promote “import substitution” products. The hike in repo rate and consequent MCLR changes by the banks in the upward direction will result in an increase in interest rates for housing loans, builder loans, and vehicle and personal loans, thus resulting in an increase in their EMIs which will be a great dampener during the festive season.

A repo rate hike by 30-50 bps is imminent. What is interesting to watch will be the tone of the policy which should be hawkish rather than dovish, with a stance that is ‘neutral’ rather than ‘accommodative’, with a downward revision in the GDP forecast of RBI from 7.2 per cent to 6.5-6.8 per cent for FY23. What is called for is clarity on providing adequate liquidity to critical sectors, as the ‘system’ experienced a liquidity deficit in September,resulting in an infusion of Rs 21,873 crore last week as against a liquidity surplus of a whopping Rs 7 trillion in the recent past.