RBI may hike repo rate, but will do well not to

The Reserve Bank of India’s Monetary Policy Committee (MPC) will face a difficult decision today on whether to reduce the repo rate or not, and to what extent, against the backdrop of CPI inflation in October falling to a three-month low of 6.77 per cent (September: 7.41 per cent), though remaining well above the RBI’s upper tolerance limit of 6 per cent for the tenth consecutive month, and slow GDP growth in the second quarter (Q2 July-September, 2022) of 6.3 per cent from 8.4 per cent year-on-year.

The growth is sharply slower than the 13.5 per cent recorded during the last quarter, Q1 of April-June 2022.

The MPC has raised the repo rate, the rate at which the banks borrow from the RBI, continuously by 190 basis points since May 2022, from 4 per cent to 5.9 per cent, a 50-bps hike during the last three policy announcements.

Many developments, both globally and locally, have occurred in the two months since the RBI’s rate hike in October, which will weigh heavily on the MPC’s minds when deciding on the quantum of the repo rate hike, stance, and tone of policy.

Worst is the GDP Q2 (July-September 2022) slowdown to 6.3 per cent from 8.4 per cent YoY, higher inflation, fading base effect advantages, price pressures due to volatile commodity prices, dwindling exports, inelastic imports (we import 85 per cent of our oil requirement), and the widening of the current account deficit, which will eventually impact our fiscal deficit.

What is more worrying is the corresponding 5.6 per cent slowdown in Q2 gross value added (GVA) reflects the real pain pressures and sector-wise positions of economic activity from the production side.

In effect, the country’s gross domestic product (GDP) and GVA in Q2 (July–September 2022) have exposed the fragility and volatility—both from the production (supply) and consumption (demand) sides.

Another big concern is the negative growth in the Q2 GDP of the manufacturing sector by (-) 4.3 per cent and the mining sector by (-) 2.8 per cent, which impacts job creation and income generation.

The October index of industrial production (IIP) again exposes fissures in four out of the eight core industries that have contracted: crude oil (-) 2.2 per cent, natural gas (-) 4.0 per cent, refinery products
(-) 3.1 per cent, and cement (-) 4.3 per cent.

The growth of the eight core industries has dipped to a meagre 0.1 per cent in October, a 20-month low. It was 8.7 per cent in October of last year and 7.8 per cent in September of this year.

To make matters worse, government spending has contracted by 4.4 per cent, despite the fact that it should have been at “high speed” to drive economic growth by increasing CAPEX and providing a significant boost to the much-needed investment cycle via the multiplier effect by accelerating and generating employment, income, and savings to ensure long-term and sustainable economic growth.

The silver lining has been a Q2 GDP increase in agricultural growth at 4.6 per cent, private final consumption expenditure at 9.7 per cent, gross fixed capital formation by 10.4 per cent, November PMI manufacturing at 55.7 vs. 50.3 in October (a festival period rise is not a litmus test and cannot be taken as “durable growth”), services PMI uptick at 56.4 (55 in October ) and composite PMI at 57.7. All these positive indicators boost investment sentiment.

Despite the RBI’s rate hikes, banks have begun lending aggressively in the last two months. Banks’ balance sheets are strengthening as a result of “lesser provisions,” improved net interest margins (NIMs), asset quality improvements, and lower non-performing assets (NPAs).

The credit off-take by banks and housing finance companies has been more than 17 per cent, with a focus on lending to affordable housing, construction finance to builders, MSMEs, and infrastructure.

It would be most appropriate for the RBI to maintain the status quo on the repo rate hike against the backdrop of a nascent recovery in private investment, robust credit off-take, negative growth in the manufacturing and mining sectors, which requires growth push policy support from the government and the RBI, the US Federal Reserve sounding less hawkish, Brent crude oil prices softening to less than $85 per barrel, rate hikes by the RBI having limited impact in dealing with supply-side bottlenecks, and most importantly, the central budget on February 1, 2023, which will provide the key indicators of growth path and sectoral allocations for the next fiscal year. The RBI would do well to adopt a wait-and-see approach, signal neutrality with a dovish tone, and boost investment sentiment even though a token repo rate hike of 25–35 bps appears imminent.

(The writer is a former
banker. )