RBI Policy: Will MPC guide for an inter-meeting rate hike?

The MPC’s mandate is to keep inflation at 4 percent (+ or -2 percent). Right now inflation is surprising on the upside. In the upcoming policy, RBI will have to revise its third-quarter forecast from 4.5 percent to 5-5.3 percent. The fourth quarter CPI forecast will also be revised from 5.8 percent earlier to 6.1-6.3 percent. The forecast for the first quarter of the next fiscal (Q1FY23) will also have to undergo a similar exercise from 5.2 percent to may be 5.5-5.6 percent.

This means for the next 12 months inflation is all set to remain well above 5 percent. Of course, anything below 6 percent need not worry MPC or the RBI much, except that it means the margin for error becomes too narrow.

The 65 basis point difference between repo and reverse repo rate was always meant for a shell-shocked, standstill economy. Now that growth is normalising and the Q2 GDP is a good half a percentage point above RBI forecast, emergency measures like a reverse repo rate, 65 bps below the repo rate, is tough to justify.One MPC member has already worried about the institution’s credibility. Any persistence of inflation or an external accident can force the RBI to take hasty steps. It’s better to move now when the situation is calm.

Some economists believe that if the rate that banks get for idle money is kept ultra-low, bankers will perforce lend. This hasn’t been the case so far. Loan growth is running at a measly 7.3 percent.  Bankers in fact say some of their loans are benchmarked to the repo rate, and they are making nothing on some of these loans. A slightly higher market rate may actually goad them to lend.

India’s current account deficit has suddenly started shooting up since September, after a surprise surplus in the first quarter of FY22. A combination of high current account deficit, high fiscal deficit, rising inflation and ultra-loose monetary policy can be a bad combo of macros, should the external sector throw up some shocks. And shocks can't be ruled out with the Federal Reserve announcing it may start to taper excess liquidity more aggressively.

Finally, a reverse repo hike won't move the needle much because short term rates have already moved up in sync with the higher cut off yields in the 7-day, 14-day and 28-day variable rate reverse repo auctions. The cut-offs in these auctions have been at 3.95-3.99 percent since the end of October.  RBI has absorbed almost Rs 7.20 trillion through the variable rate reverse repo windows. Less than Rs 2 trillion goes into the fixed-rate reverse repo window at 3.35 percent. If this moves to say 3.5 percent, short term rates wont rise, but the move will have the advantage of averting the need for sharp hikes later.

Besides this guidance on rates, the market will look for the RBI’s assessment of the impact of the new variant on growth, its reaction to the Feds decision to taper more aggressively as also its comments on the rising current account deficit. Much of the press conference may well be hijacked by questions on cryptocurrencies.

To come back where we began, nothing much is lost if the RBI keeps rates status quo for two more months. It may have more clarity on the impact of the Omicron variant by Feb 8 when the MPC meets next. Also on Feb 8, RBI may have 2 CPI readings of November and December which are likely to be much closer to the 6 percent mark. The RBI may be better able to justify the reverse repo hike then. One only hopes this benign argument isn’t waylaid by unexpected events.