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With inflation raging across the globe, Central banks are in a fix. Rates are being hiked across the board. The Reserve Bank of India, on their end, is prioritising inflation over growth, which is manifested by the recent hikes in repo rate. The RBI had revised upwards its inflation projection to 6.7 per cent for the current fiscal from its previous forecast of 5.7 per cent.
The apex bank had recently raised the interest rate by 50 basis points to a two-year high of 4.9 per cent. The rate hike came on the back of a 40 basis-point increase effected at an unscheduled meeting on May 4. Hoever, the RBI also assured that despite the Russia-Ukraine conflict disrupting the global supply chain, India's external sector remains healthy, and the current account deficit (CAD) is sustainable with normal capital flows.
Indranil Pan, the chief economist at Yes Bank feels the RBI could raise its benchmark policy rate to around 6.0 per cent by December. While raising interest rates is necessary to tame inflation, Pan also tells THE WEEK that it will have some adverse impact on growth this year.
Excerpts from an interview:
Q. After a prolonged pause, the RBI has now raised the repo rate by 90 bps. How much more do you think will RBI raise the repo rate before it pauses or gauge the impact?
We think that the RBI will be front-footed and would increase the repo rate by another 35-40 bps in August. While the pace of hikes is debatable, we think that the RBI will want to raise the repo rate to 5.80-6.0 per cent by December and then pause to assess the impact of the same on growth-inflation mix. This is also predicated by the fact that the current inflation estimate of RBI is at 5.8 per cent and thus the repo rate of 5.8-6.0 per cent would enable the RBI to push the real rate to the positive zone.
Q. In the backdrop of the repo rate hike and liquidity tightening, how are interest rates going to move this year? We have already seen repo-linked home loan rates rising.
Loan rates will obviously be rising—banks have already started raising MCLRs (marginal cost of funds-based lending rate) and the pass on of the repo rate to fresh loans will be via the EBLR (external benchmark-based lending rate) mechanism. However, in this round of rate increases we think that the lending rates would possibly rise faster than the deposit rates and could be beneficial for the margins of the financial sector. This is because even as credit growth is evident, banking sector liquidity remains adequate.
Q. A lot of the inflation we are seeing today is linked to food, supply-side bottlenecks and Ukraine-Russia conflict. How much will RBI be able to tame inflation by raising rates?
The current attempt of the RBI is to try and prevent inflation expectations rising sharply and also to maintain the credibility of the inflation targeting central bank. At the margin, demand will get impacted and inflation could be restrained from rising higher. Supply side inflation would however need supply side responses and we hope that a good monsoon could arrest food prices.
Q. The govt, among other things, has recently cut duties on petrol and diesel. What more do you think needs?
Government response to the inflation has been proper and is supportive of the RBIs efforts to cool inflation. Unfortunately, even as the fiscal remains weak, a significant amount of the cost of inflation will have to be absorbed by the fiscal—such as through excise cuts on petro products, import duty cuts and higher fertiliser subsidies. On an immediate basis, no new policy measures may be needed and the government will have to observe the evolving global situation on commodity prices.
Q. Where do you see retail inflation this year?
We expect retail inflation to have already peaked, especially with the aggressive tightening from the RBI and support from the government in reducing inflation pressures amongst common masses. We expect inflation to average at around 6.4 per cent in this financial year, even as a sustained dip below the 6 per cent level could be pushed out to fourth quarter of the current financial year (2022-23).
Q. The rate hikes come at a time the GDP growth has been slow. What impact will the rate increases have on economic recovery?
The whole purpose of the rate hike is to reduce inflation expectations in the economy and therefore effectively cool demand pressures at the margin. Higher rate would surely come at the cost of growth. We expect real GDP for the year to average at 7.0 per cent with some downside risk, mainly coming out of lower domestic as well as external demand. Unfortunately, the fiscal is also stretched and may not be able to provide any incremental support to the growth momentum.
