Constituent policy

RBI policy-making in turbulent times: Bond markets forecast another no-nonsense rate hike at MPC meeting in August

By Churchill Bhatt

Unlike the surprise rate action between meetings last month, today’s outcome from the Monetary Policy Committee (MPC) was broadly in line with market expectations. The MPC raised policy rates by 50 basis points (bps) and remains determined to withdraw the accommodative policy. While the RBI refrained from raising the CRR this time, it will continue to normalize excess liquidity in the system in a calibrated manner. Given the mounting price pressures, the RBI revised average inflation for FY23 upwards by 100 basis points to 6.7% while maintaining the GDP growth projection for the fiscal year 23 unchanged at 7.2%.

The MPC sees future inflation risks broadly balanced after the massive upward revision of its forecast. While the committee acknowledged that the government’s recent excise duty reduction and other measures should help ease price pressures, this support for inflation comes at a fiscal cost. Therefore, the government will either have to borrow more or spend less in order to reduce inflation. But again, the impact of government measures on inflation is immediate, while the resulting fiscal cost comes with a time lag. On the contrary, RBI’s anticipated rate hikes will take months to produce the desired effect.

Interestingly, inflation, while being a monetary phenomenon, also has an important psychological component. This behavioral aspect of inflation must be addressed as much as the monetary aspect. In addition to its action, MPC communication is a tool often used to influence inflation expectations. To that effect, the MPC communication this time around is characterized by a key modification, that is, the committee has deliberately avoided specific guidance for future action. In a sense, this reflects the volatility of geopolitical and economic landscapes.

We live in an age characterized by high volatility and sheer unpredictability. As prices remain uncomfortably high and the pace of central bank tightening picks up, global economic growth is expected to slow. At the same time, inflation is expected to decline from very high levels to somewhat lower but still above desirable levels. Financial markets may, rightly or wrongly, perceive this slowdown in growth as a precursor to recession and see this slight drop in inflation as the end of high inflation.

Regardless of the end result, we expect to see a lot of noise around growth and inflation over the next few months. However, extrapolating the first data may not be the right way to judge a rapidly changing world. In our view, there is still time before we can determine whether the slowdown in growth will turn into a recession. Similarly, a decline in inflation from the peak may not be proof of its demise.

Despite all the uncertainty, bond markets are currently pricing in another no-brainer rate hike of 35 to 50 basis points in August policy. The trajectory that follows will most likely be characterized by a measured tightening of monetary policy, the extent of which will be determined by the growth-inflation dynamics at the time. Currently, bond markets are pricing in the final policy rate between 5.50% and 6% by March 2023. Unlike the markets, RBI does not yet want to commit to a forward policy trajectory.

Wiser now, RBI wants to keep its policy options open to all eventualities in this turbulent era. Confused communication and the absence of explicit forward guidance can be a useful central bank strategy during these times. In a lighter vein, the situation is reminiscent of the following statement by former Fed Chairman Alan Greenspan – “Since becoming a central banker, I have learned to mumble with great incoherence. If I seem too clear to you, you must have misunderstood what I said”. Need we say more!

(The author is the Executive Vice President of Debt Investments of Kotak Mahindra Life Insurance Company. The views and opinions expressed in the column are personal and do not necessarily reflect the opinion of the organization or the Kotak Group. (The views expressed do not reflect the official position or policy of