RBI stuns with super dovish policy; April is another year

So what may be the assumptions of this 4.5 percent CPI for FY23? Or the justification for wantonly missing the bus on hiking the reverse repo rate by even 15 basis points?

Firstly, on reverse repo, technically, hiking the reverse repo rate actually puts more money in the hands of banks as RBI pays them a higher amount for keeping money idle. So a reverse repo hike is not a  sign of tightening. However, the normative difference between repo and reverse repo rates is 25 basis points and this corridor was raised to 65 basis points in May 2020, by a sharper cut to the reverse repo, only to coax banks to lend more. But if the economy is no longer in the grip of lockdowns, shouldn’t the current gap of 65 basis points between the two rates be reduced as a sign of normalisation?

The RBI governor did say that, since they haven’t changed the stance, there was no need to hike reverse repo. This has set the cat loose among the pigeons, since most fixed income participants expect the RBI to bring down the corridor between reverse repo and repo to 25 basis points, and then change its stance. The governor’s reply has confused the market about the expected sequence of normalisation. But more importantly, this statement, along with the guidance for a continued accommodative stance, has pushed back market expectations of rate hikes by a quarter or two. While several economists were expecting a stance change and a repo rate hike by June, most have now shifted this expectation to the second half.

The RBI can’t be faulted on its rates policy and guidance, if its inflation forecast is right. But many economists are finding it difficult to swallow a 4.5 percent CPI forecast for the full year or a 4.9 percent CPI forecast for the April-June quarter.  Firstly, oil companies haven’t raised petrol and diesel prices since November 4. Crude prices stood at $75/barrel that day. The market calculated that if a 10-15 dollar rise in crude prices hence gets passed on, fuel prices will rise by at least Rs 7-8 per litre, pushing up CPI by close to 30 basis points, counting second-order impact on other goods. However, the RBI appears to have assumed that the rise in crude prices won't be passed on; does it have a reassurance from the government on this issue? “Government and RBI are in constant dialogue on all issues,” was the governor’s reply.

Secondly, economists are scratching their heads over the RBI’s crude price assumptions. Citibank has one of the most dovish crude price assumptions of $67 per barrel for 2022, but even Citi India’s CPI forecast for FY23 is over 5 percent.  So, is the RBI assuming an even softer crude price? Or is it expecting global supply chains to recover from their deep disruption and push down global inflation? All that the governor said was that the RBI has taken into account all scenarios. At any rate, the RBI’s assumptions for the next year will be known in detail only when it releases the Monetary Policy report along with the April policy. But for now, it does appear that a lot will have to go right in geopolitics and the global supply side economics for the RBI’s CPI forecast to be right.

The RBI is walking in a direction opposite to the US Federal Reserve, the England Central Bank and the Bank of Europe. India’s inflation, which usually runs 200-300 basis points above the US CPI, is now running 200 bps below that US CPI. Clearly, inflation today is a developed economy problem and as the governor said, the second largest economy, China, is now loosening its policy. The RBI can’t be faulted for charting a course different from that of developed countries' central banks, but what appears open to question is the assumptions underlying its inflation forecast.

The governor has reiterated RBI’s commitment to financial stability time and again. But for now, one-day money at 3.35 percent at a time  inflation is running at close to 6 percent appears ultra loose. In the past, the co-existence of a loose fiscal policy along with a loose monetary policy has spelt trouble 2-3 years down the line. Hopefully, this time is different.