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Rate hike and further policy catch up find consensus among MPC members:

Minutes of the August MPC meeting, which saw another 50bps hike with a unanimous vote and no revision in inflation forecast, depict members’ continued urgency towards policy catch up amid their reassessment of the inflation outlook. Broadening of inflation pressures and generalization & persistence of inflation made most members uncomfortable, even though some reckoned the largely imported nature of the current inflation. Most believe that amid fears of second-round effects on expectations, an early hike is necessary for avoiding any unintended economic shocks, and there is need to aggressively hike later, as also to maintain policy credibility. All members largely maintained their change in stance to withdrawal of accommodation as appropriate, as policy rates are directionally poised to increase

Terminal rate conundrum amid risk of sacrificing higher-growth

While all members reckoned rates need to go up further, the August minutes (unlike June minutes) show a mild convergence towards a lower terminal rate. Prof. Goyal sees the current real policy rate already near neutral, based on year-ahead inflation estimates and, thus, suggested the need to carefully monitor evolving data developments, pace of US rate hikes ahead and policy reaction function. Dr. Patra (and Dr. Ranjan) insisted that monetary policy credibility is the timing of its response and so stressed on the need to frontload policy rate hikes for anchoring inflation expectations, reducing second-round effects and mitigating the growth sacrifice. Prof Varma, while explaining his dissent, suggested that a continuation with the current policy resolution ? to remain focused on withdrawal of accommodation ? confuses more than it clarifies. It would perhaps signal the MPC's intention of a terminal rate of 6.5%. He however feels this high a terminal rate is unwarranted, given prevailing uncertainties, expected global slowdown and evolving growth & inflation dynamics ? all of which could perhaps warrant a terminal rate well below 6.5%. Meanwhile, Dr. Ranjan stated that the faster transmission of rate hikes under the external benchmark regime should be considered while arriving at the terminal rate. Overall, most members seem to be rationalizing front-loaded rate actions as timely policy responses which would lower the terminal rate and reduce sacrifice ratios in the current cycle.

Inflation pressures broad-based, while external risks warrant a watch

While MPC members agree that inflation appears to show signs of moderation, they reckon it remains unacceptably high and requires a policy push, to bring it within target at the earliest. The broad-based nature of inflation pressures was highlighted by a few MPC members; there was also discussion on the risk of (1) second round impact, (2) wageprice spiral, (3) resumption of firms’ pricing power, (4) uneven monsoons, (5) FX depreciation. Dr. Patra added that each country is on its own, to either match the Fed or face FX depreciation risks, imported inflation, high BoP deficits and reserve losses. Meanwhile, Prof Goyal emphasized that policy rates should only respond to growth-inflation dynamics and not to exchange rate movements – for which they have ample other instruments.

Terminal rate still tracking +5.75%

We think we are near-peak RBI-hawkishness led by falling risk premia of the entire commodity price complex, and that incremental rate hikes will be lower. But we understand the situation globally is still fluid, and macro assessments might require frequent adjustments from the policy perspective. While inflation may remain elevated in the near term despite Peak-Inflation, a slide is likely in 4QFY23. We are also closely watching the global pace of inflation deceleration and how the impending recession will shape DM central bank policies, which could have implications for the RBI. We reckon recessions are strong global disinflation agents, but price-stickiness will make the disinflationary path non-linear in coming months. (See ‘Peakflation vs. Recession; Stairway to Heaven or Highway to Hell’). Terminal rate is still tracking +5.75%: We maintain FY23 could see RBI policy rates terminating at 5.75-5.90%, with the central bank showing intent to keep real rates near the estimated natural rate. To us, need for terminal rates to move markedly higher than this seems low at this point (See ‘Hikes FOMO: Be careful what you wish for…’), while system liquidity may improve ahead, as government spend and net liquidity tightening to 2-2.5% of NDTL by end-FY23 (per our estimate) would also tantamount to another estimated +25bps rate hike, thus implying less pressure on conventional repo hikes ahead. ? The minutes of the August MPC meeting reflect continued policy urgency and catch up with heightened inflation uncertainties. The persistent-inflation narrative saw coherence among members, with most rationalizing front-loaded actions as means to a relatively lower sacrifice ratio overall. ? The issue of real terminal rates seems to find a mild convergence among some members. While Prof Goyal believes we are now at neutral real rates and suggested cautiously moving ahead, Prof Varma believes the terminal rate is unlikely to touch the highs of 6.5% and appears comfortable with real rates becoming modestly positive. Dr. Ranjan stated better transmission means lesser pressure on policy hikes. ? We are closely watching the global pace of inflation deceleration and how the impending recession will shape DM central bank policies, which could have implications for the RBI. We maintain that FY23 could see RBI policy rates terminating at around +5.75%, with the central bank showing its intent to keep real rates near the estimated natural rate. While system liquidity may improve ahead as government spends and net liquidity tightening to 2-2.5% of NDTL by end-FY23 (per our estimates) would also tantamount to another estimated +25bps rate hike, implying less pressure on conventional repo hikes ahead. This report is intended for team.emkay@whitemarquesolutions.com use and downloaded at 08/22/2022 02:27 PM This report is intended for team.emkay@whitemarquesolutions.com use and downloaded at 08/22/20

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