The Reserve Bank of India (RBI) possibly does not get enough credit for the kind of challenges it faces, both internal and external. The RBI is encumbered with a rather thankless task of maintaining fiscal stability while ensuring a fertile environment for growth. Yet, it has done a stellar job, particularly over the last couple of years in the wake of the global pandemic, and is likely to again be the bearer of firewood, as we brace for economic winter.
The global economy may soon be about to see a third phase of contraction since the 2009 Great Financial Crisis (GFC), something that even US Federal Reserve Chairman Jerome Powell admitted to be a possibility given the pace of rate hikes that the Fed has embarked upon. The US markets have been in a heightened state of activity, with the Fed following through, for now, with its narrative of tightening the liquidity conditions through quantitative tightening (QT, or the process of sucking excess liquidity from the system) and with a hike to the Fed funds rate.
The interconnectedness of the global economy, underpinned by the reserve currency status of the US Dollar, has forced central banks around the world to follow suit, irrespective of the state of their economies. While curtailing inflation has been a priority across the globe, many tend to forget that this inflation has been imported from the US on account of the latter’s loose monetary policies of the last decade.
Policy Moves
The last Federal Open Market Committee (or FOMC) meeting saw Powell show resolve in increasing rates to tame inflation, with an increase in the benchmark rate to a 3-3.25 percent range, the highest since 2008.
While India has not been immune in the past to the US monetary policy movements, 2022 has been a relative period of quiet. The relative resilience of the Indian Rupee and by corollary the economy has been attributed to better access, demographic dividend, start-ups, and government policies. While all these factors have contributed, the role of the RBI policy stance goes largely underappreciated.
The RBI approach to rate hikes is a great example to buttress the above point. The RBI has raised the repo rate by 140 bps, since the beginning of 2022, on a base of 4 percent. In sharp contrast to the US Fed raising its target rate by 3 percent on a base of near zero, the RBI’s repo rate hike trajectory has been a lot less steep.
Instead of trying to follow the US Fed’s cue on rate hikes, the RBI has taken a slightly different course, and paced the hikes to focus on the challenges of the Indian economy. While the Fed’s need to rein in debt is evident, the data of the last two decades points towards the futility of this exercise.For every one percent rise in the interest rates, the interest burden will shave off nearly 4 percent from the US GDP, which emboldens Powell’s assertion about a likely recession.
Also, one cannot ignore the six-to-nine-month lag in monetary policy transmission, and the cascading effect it will have on the economy. While the US is almost certain to see a contraction as large hikes ripple through the economy at a record pace, in India’s case, the impact on growth trajectory is likely to be less onerous. Furthermore, a near normal monsoon, and the upcoming festival season without the COVID-19 restrictions of the last couple of years should further bolster the sentiment.
While the Fed is trying to make the world believe that QT has set in, the sustained level of the Fed balance sheet along will increasing rates will only add to the interest burden of the US.
As the RBI’s monetary policy committee meets from September 28, the committee will be looking at inflation, considering seasonally tighter monetary conditions in September and the impact of the lag in policy transmission while hiking rates. The current rupee depreciation may be less of a concern if the imminent US Fed rate cut cycle’s impact on the calendar year-end exchange rates is considered.
Considering where the US mortgage rates are, the smart money should be lining up to enter India, which, while benefitting the Indian markets, will also possibly contribute to the imported inflation. Once again, we will expect another measured intervention from the ever-reliable RBI.