The Monetary Policy Committee (MPC) of the Reserve Bank of India has decided to further increase the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points. As a result, the repo rate has increased from 5.40 per cent in the last Monetary Policy instance to 5.90 per cent now. Accordingly, the standing deposit facility (SDF) rate has been adjusted to 5.65 per cent and the marginal standing facility (MSF) rate and the Bank Rate have been raised to 6.15 per cent. Besides, the RBI shall continue to focus on the withdrawal of accommodation to ensure that consumer price index (CPI) inflation remains within the target of 4 per cent within a band of plus – minus two per cent, supporting growth nevertheless.
Earlier this month, the US Federal Bank (Fed) had decided to raise the policy rates by 75 percentage points consecutively considering the domestic and global cues including the inflation having been much higher than its target of two percent and so it was much expected that RBI may follow the suit on the same grounds.
Global cues affect all Nations in one or the other way
Despite a raising of the policy rates by 50 basis points last month, inflation persisted above the RBI targeted levels. Besides, the global economic activity continued to decelerate due to the prolonged war between Russia and Ukraine and the resultant hawkish monetary policy stance by the majority of central banks across the World. This led to the tightening of the financial conditions and made the global financial markets volatile.
To add to the woes, the US dollar strengthened to a 20-year high on account of sporadic sell-offs in equity and bond markets due to higher interest rates in the US economy and the uncertainty about the global economy. As the foreign portfolios squeezed, the emerging market economies (EMEs) were under tremendous pressure facing currency depreciations, loss of foreign exchange reserve, financial stability risks, in addition to the global inflation shock. Higher commodity prices imply rising import bills and reduced demand for exports for a developing country and India was no exception.
There are positives in domestic economy
In the first quarter of the financial year 2022-23, the real gross domestic product (GDP) grew by 13.5 per cent and the gross value added (GVA) grew by 12.7 per cent on year-on-year (y-o-y) basis. There is growth observed in the aggregate supply conditions across sectors including the pandemic-hit service sector. Further the monsoons have been better than their long period average (LPA) as on September 29 and have even reached out to some deficit areas.
As a result, it is expected that the kharif sowing may turn out to be normal eventually. Further, it is projected that the Government’s continued thrust on capex may bring about improvement in capacity utilization in the manufacturing and infra sectors. There is an increase in non-food credit which may support the rise in industrial production. Further, there is an upsurge in the urban consumption on account of increase in discretionary spending in view of the forthcoming festival season and rural demand too is gradually improving. Besides, investment demand is also improving as imports, domestic production of capital goods, steel consumption and cement production are all on the higher levels. Not only this, despite a shrinking global economy, merchandise exports too managed to grow in the month of August.
Inflation continued to haunt though
CPI inflation increased to 7.0 per cent (y-o-y) in August 2022 from 6.7 per cent in the previous month largely due to rise in food inflation. Besides, the fuel inflation remained in double digits and core CPI (i.e., CPI excluding food and fuel) inflation continued to be at heightened levels. Yet the overall system liquidity remained in surplus. India’s foreign exchange reserves were at an impressive level of US$ 537.5 billion as on September 23, 2022.
Despite expectations of some easing of input cost and output price pressures in the light of the recession risks looming over the advanced economies and the observance of many positives in the Indian economy, the inflation outlook is marred by high and prolonged uncertainty due to the geopolitical conditions. Besides, there is uncertainty about crude oil prices pending peaceful resolution of the geopolitical tensions. Considering these factors and assuming that the crude oil prices may hover around US$ 100 per barrel, the RBI projects inflation to be at 6.7 per cent in the financial year 2022-23, and a gradual decline to 5.8 per cent in the last quarter. The RBI projects the CPI inflation to decline to 5 per cent in the first quarter of the next financial year (Chart 1).
Thus, the RBI has taken a hawkish stance for now hoping that growth may eventually pick up once the inflationary pressures are eased out. In a globalized world it is important to tackle the external shocks in an effective manner. There is need to synchronize the fiscal and trade policies with the objectives of the monetary policy and vice versa.