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Below is quote on RBI policy by Mr. Dhananjay Sinha , Managing Director & Chief – Strategist, JM Financial Institutional Securities Ltd

Two risks on external balance are pronounced, a) widening trade deficit and b) continues portfolio retrenchment due to tightening global financial conditions. The sequence of correction in global commodity prices and recent restrictions on exports (steel, iron ore, agri produce) would imply a deceleration in exports while oil imports continue to remain elevated in the foreseeable future. This will continue to see widening trade deficit. 

The combination of external vulnerabilities and higher fiscal deficits will complicate matters for RBI as it juggles between multiple objectives of inflation control, orderly currency and Gsec yield scenario. Our assessment indicates that RBI’s currency management in the face of rising US rates and strong dollar has translated into rising exchange rate rigidity and it reflects in decline in RBI’s forex reserve by USD 42bn from the peak to USD 600bn. Thus, in the context of continued rate and quantitative tightening by the US Federal Reserve will result in both liquidity moderation in India along with further rate hikes.

Separately, inflation management is tricky as the real repo rate is deeply negative at -3.4% (4.4%-headline CPI at 7.8%) and -2.6% assuming core inflation of 7%. Thus, to arrive at a neutral real rate of 1% RBI will have to substantially increase the repo rate and tighten liquidity. Assuming that core inflation softens to 6% in the next 12 months the short term rates will have to be at 7% from the current level of ~4% (overnight call money rate). This would ideally call form about 200-250bp addition repo rate hike. Over the next 12 months RBI can be expected to hike rates by 150bp at least and a 40-50bp hike on Jun 8th.

What can change the medium term scenario is the possibility of a global recession or a hard landing translating into an early financial market capitulation and collapse in global commodity prices.

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