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The Monetary Policy Committee (MPC) voted for a back-to-back repo rate hike of 50 basis points (bps) in its August 2022 policy review, with the anchoring of inflationary expectations taking centre stage. The CPI inflation and GDP growth projections for FY2023 were retained at 6.7 per cent and 7.2 per cent, respectively, with risks evenly/broadly balanced, while the stance was kept unchanged in a non-unanimous vote.
That the repo rate would be hiked was a foregone conclusion. However, the market was divided about the magnitude, with forecasts ranging from 25-50 bps. The actual size of the hike exceeded our own expectations of 35-40 bps. This was based on the anticipation that the MPC would lower its CPI inflation projection to 6.5 per cent from 6.7 per cent, which did not turn out to be the case.
After the alarming print of 7.8 per cent in April 2022, the CPI inflation had softened to 7.0 per cent each in May-June 2022. Accordingly, the average inflation for the quarter stood at 7.3 per cent, slightly lower than the MPC’s forecast of 7.5 per cent, while remaining well above the tolerance band of 2.0-6.0 per cent.
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Subsequently, global commodity prices have corrected amidst fears of a recession as well as fresh sources of geopolitical tensions. The monsoon is uneven, albeit above normal, while reservoir levels are ample. Kharif sowing has picked up, but lags in paddy acreage pose a concern. On balance, the MPC has reduced its CPI inflation projection for Q2 FY2023 to 7.1 per cent from the 7.4 per cent indicated in June 2022.
Curiously, it has upped its inflation forecast for Q3 FY2023 to 6.4 per cent from 6.2 per cent; we believe the first sub-6 per cent readings will emerge in this quarter, especially if the downtrend in commodity prices sustains, although we remain watchful of the momentum in services inflation, given the robust demand for this segment.
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The MPC has retained the projection for Q4 FY2023 at 5.8 per cent and then projected a relief-inducing dip to 5.0 per cent in Q1 FY2024. Regardless, the latter remains above the 4 per cent mid-point of the medium-term inflation target range of 2-6 per cent.
Moreover, the MPC retained the FY2023 GDP growth forecast at 7.2 per cent, in line with our view, although our quarterly forecasts remain quite different from the MPC’s. In addition, the MPC voted 5:1 to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. The MPC minutes will throw more clarity on the nature of Professor Jayanth Varma’s reservations.
Overall, the tone of today’s policy was modestly more hawkish than what we had anticipated, given the cooling of commodity prices and our anticipation of a relatively softer outlook for the inflation readings going ahead.
Today’s rate hike has taken the total magnitude of the increase after May 2022’s surprise decision, to 140 bps. This is nearly in line with the 150 bps of rate hikes undertaken by the US Federal Reserve in June-July 2022, with additional tightening on the cards.
Given the emphasis placed by the MPC on anchoring inflationary expectations, we believe rate hikes will continue until sub-6 per cent CPI inflation readings become a near-certainty. Therefore, we are convinced that there will be another rate hike in September 2022, even if its quantum is as small as 10 bps.
If the CPI inflation appears highly likely to fall sub-6 per cent in Q3 FY2023, which is our baseline projection, we foresee a pause from the MPC in the December 2022 policy review.
(The writer is Chief Economist, ICRA Limited. The views expressed in this article are personal.)
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