Monetary Policy: How key economic indicators shaped up since MPC’s August review meet to policy decision tomorrow

The Reserve Bank of India-led rate setting panel is widely expected to raise the benchmark rate for a fourth straight time at the end of its policy review tomorrow, in line with tightening measures by global key central banks.

The Monetary Policy Committee is expected to raise the repo rate by 50 basis points. However, the pace of monetary tightening will be largely guided by domestic economic indicators, as analysts flagged that significant risks to India’s growth and inflation trajectory have emerged.

“While risks to growth are driven by a slowdown in global growth, risks to inflation are more domestic in nature,” Bank of Baroda Economist Sonal Badhan said in a research note. “Other key developments which will be considered by the RBI will include volatility in the currency and bonds market.”

HDFC Bank‘s Principal Economist Sakshi Gupta said the central bank is unlikely to take its foot off the tightening pedal for now as inflation is expected to remain above the RBI’s upper tolerance band of 6% until February 2023 and moderate below 6% from March 2023 onwards.

“Moreover, we believe that with the aggressive global tightening continuing (Fed raised rates by 75 bps for the third time, ECB raised rates by 75 bps), the case for RBI to continue front-loading its rate hikes – providing a soft defence for the rupee – has become stronger. We now expect the RBI to take rates up to 6.25-6.5% by fiscal year-end,” she said.

To recap, RBI Governor and MPC Chair Shakitkanta Das in the last policy said they will do ‘whatever it takes to cool inflation that has not been in any mood to ease below 6%. Since the last meeting, price pressures have intensified again and India’s local currency has slumped to a nadir courtesy of an aggressive Fed that amplified the hawkish tone.

On that note, let’s take a look at the movement of key economic indicators since the last policy meeting in August when the rate-setting panel had hiked the benchmark rate by half a percentage point to lower ‘unacceptably high inflation’ and stuck to the path of focusing on withdrawal of accommodation as the strengthening economy gives it elbow room to tighten monetary conditions.

Inflation:

One of the key drivers for the policy decision will be the inflation readings and their trajectory.

Retail inflation in India had surged to 7% on an annual basis in August from 6.71% in July, snapping a three-month downtrend. The print stayed above the RBI’s tolerance ceiling of 6% for the eighth consecutive month. Consumer prices in India had surged to an eight-year high of 7.80% in April. The overall food inflation came in at 7.62% in August as compared with 6.75% in the preceding month, while fuel and light inflation fell to 10.78% in August from 11.76% in July.

In the August policy, the RBI had left the inflation projection for this fiscal unchanged at 5.7%, despite acknowledging that inflation had peaked.

There is some moderation seen in global commodity prices with oil falling to a multi-month low, but risks to inflation are more domestic in nature, with food inflation being a major challenge, economists said.

Rupee Vs. Dollar:

The Rupee has depreciated around 9% against the greenback so far in the calendar year 2022 and it hit a record low of 81.9 yesterday as the yield on the US 10-year Treasury touched 4% for the first time since 2010.

The RBI has tried to hold the rupee below 80, but the rupee in recent months yielded to the pressure from the interest-rate hikes by the US Federal Reserve.

The dollar index, which measures the US currency’s relative strength or weakness against a basket of currencies, is at its highest since the turn of the millennium. Just shy of 114, the gauge has climbed more than a fifth in a year, with nearly half of that appreciation accruing in the past three months.

The RBI has used its forex stockpile across platforms – spot, futures, forwards and non-deliverable forwards markets – to prevent the rupee’s rout in calibrated interventions. But the sharp dollar surge, which hasn’t spared even the pound, euro and the yen, has prompted the hunt for measures beyond conventional interventions that use up assiduously built reserves and cause the macroeconomic picture to deteriorate.

The central bank is said to be contemplating several bespoke measures, such as opening a special window for oil importers and reducing hedging costs for foreign-currency depositors, to minimize the pace of decline in the rupee against the surging US dollar.

Forex Reserves:

India’s foreign exchange reserves got depleted by another $5.22 billion in the week to Sep 16 to hit the lowest level since Oct 2, 2020. Foreign exchange reserves also fell for the seventh straight week.

The reserves stood at $545.65 billion as against the all-time high of $642.453 billion seen on September 3 last year, Reserve Bank of India data showed.

Reserves had fallen over $15 billion over the two preceding weeks.

While dollar outflows are the major reason behind this depletion, the change in the valuation of reserves held in global currencies other than the US dollar is also partly behind this trend.

Out of the current reserves, foreign currency assets stood at $484.90 billion while reserves held in gold were valued at $38.19 billion.

Deutsche Bank recently said that India’s overall foreign exchange reserves will deplete further this year due to a ballooning current account deficit and interventions by the central bank to support the rupee.

Despite the rampant fall, government officials have said India has fairly large reserves to tide over the turmoil in the currency markets.

Trade Deficit:

India’s exports faces risk from subdued demand from developed countries and blocs such as the US and European Union following geopolitical crisis. Falling overseas shipments and increasing imports may further widen the country’s trade gap.

Exports of engineering products, which account for over 25 per cent of the country’s exports of $419 billion in 2021-22, dipped for the second consecutive month in August by about 14.5% to $8.25 billion.

India’s trade deficit in August more than doubled to $27.98 billion from $11.71 billion a year earlier. However, it narrowed from a record $30 billion in July.

“Though the August print marks a moderation from July’s record trade deficit, the deficit remains at unsustainably high levels, and is likely to raise financing concerns,” Rahul Bajoria, chief India economist said in a note.

Between April-August 2022, India’s trade deficit widened to $125.22 billion.

The widening trade gap is also a worry for the rupee as the need for dollar funding surges.

Rate Differential:


The US Federal Reserve last week hiked policy rates by 75 basis points, the third straight three-quarter point increase that lifted borrowing costs to the highest since 2008. The Fed has now taken the rate to between 3%-to-3.25% from 2.25%-to-2.50%, after starting the year with a near zero rate.

Federal Reserve Chair Jerome Powell has vowed that the monetary authority will crush inflation and signalled even more aggressive hikes ahead than investors had expected.

The dot plot suggests that the Fed will likely persist with aggressive rate hikes and the Fed Fund rate is expected to settle at 4.4% by the end of this year and rise further to 4.75-5% in the next calendar year.

Year to date, RBI has raised rates by 140 bps, while the Fed has increased policy rates by 300 bps.

The rate differential between India and other nations is a key driver for foreign fund inflows and Fed’s rate increases make the Indian market less attractive.

Global Crude Prices:

The Indian basket of crude oil had hit a decadal high of $121.28 per barrel on June 10 and was at $94.9 at the time of the last policy on August 5.

However, it has slipped below $85 recently for the first time since January despite supply side concerns due to factors including lower output from OPEC+, curbs on Russian oil imports and stalling of the Iran nuclear deal. The fall came on the back of increasing fears of lower fuel demand stemming from a likely global recession triggered by galloping rate hikes and as a surging U.S. dollar hurts non-dollar consumers’ purchase power.

Brent crude futures were at $87.69 a barrel, while West Texas Intermediate (WTI) crude futures stood at $81.73.

The price of India’s crude oil basket has dropped since June and the average as of September 22 was 90.75/bbl. In July it was $105 per barrel.

The RBI is likely to revise its oil price assumption tomorrow from the $105 level it factored in earlier.

Banks’ Credit Disbursals:


While the RBI has looked to check the run-away inflation, it will also look to keep the economy humming. Demand for loans is a key parameter to gauge economic activities.

According to RBI data, bank credit rose by 16.2% to Rs 125.5 lakh crore as of the fortnight ended September 9, aided by surging demand from corporates who are going back to banks to meet their funding requirements due to tight market rates. This may help credit growth to sustain at over 14% level for the current fiscal, the country’s top bankers said.

The 16.2% on-year growth is reckoned to be the highest growth in more than eight years and more than double the pace of growth on September 21.

Before the last policy meeting, bank credit rose by 12.89% to Rs 122.81 lakh crore in the fortnight ended July 15.

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