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* Minutes of the Sep-2022 MPC meeting echoed the widening divergence among MPC members on the future rates-trajectory. While Prof. Goyal (voted for +35bps) argued for slower and shallower hikes ahead amid data uncertainty, Prof. Varma explicitly called for a pause at this point. Both argued that the forward real rate is near-neutral and suggested caution on turning restrictive on rates amid the uncertain growth environment. Both argued that monetary-policy lags should be made an allowance for.

*  While the persistent-inflation narrative saw coherence among some members, a few diverged on policy reaction to the same. Dr. Patra and Dr. Ranjan asserted that inflation expectation could unmoor and the second-round effect would imply a higher output-sacrifice ratio later. In contrast, Prof. Goyal believed that India has limited evidence of a wage-price spiral or demand-led inflation. Prof. Varma argued that the current policy rate is sufficient for inflation to glide back to the target and suggested that the RBI should use other policy tools for managing global externalities.

* We are closely surveilling the consistent global policy re-pricing, evolution of the global pace of inflation and the effect of the impending recession on DM central bank policies, which could have implications for India. Besides, the near-term inflation outlook is fraught with substantial uncertainty. The RBI is still some time away from its supposed forward real neutral rate of 0.8-1%, even as the forward real repo rate has grown a tad positive. We reiterate the RBI may not become too restrictive and will stay within reach of the estimated neutral real rates, implying hikes of not more than 50bps ahead. But we reckon the situation is fluid and the extent of global disruption will also remain key to the RBI's reaction function ahead.

Global externalities weigh on the MPC, but with varying degrees

Minutes of the Sep-2022 MPC meeting, which saw another 50bps hike with a 5-1 split (Prof. Goyal voted for 35bps), depicted the members’ continued urgency on policy catch-up, for reversing the steep pandemic-era cuts. The broad underlying narrative, which may have moved them all, was similar to the policy: the world order is changing, and outsized Fed hikes will lead the synchronized global monetary-tightening cycle. Dr. Patra highlighted the instability inherent within the classic EM central bank impossible trinity. However, not all members believe global externalities and financial conditions should override domestic dynamics beyond a point. Prof. Goyal stated that communication has a greater impact for EMs and, thus, frontloading could overshoot. Prof. Varma added the MPC cannot be guided by the effect of the global monetary tightening on the interest-rate differential, with Prof. Goyal stating that high-risk premia for EM/India-DM carry trade is not a stable source of financing. Keeping a so-called spread of 300bps with Fed rates does not guarantee consistent debt-flows, but could have negative ramifications. She also highlighted the difference in the fiscal & monetary response of DMs and EMs and so argued for a differentiated approach amid diverse economic backdrops. Governor Das added that financial & external sectors continue to be under close scrutiny.

Explicit doves appear on terminal rate; Prof. Varma calls for a pause

Prof. Varma and Prof. Goyal were explicit doves, with the former calling for a pause. Both argued that monetary policy acts with lags, and transmission has yet to percolate to the broader spectrum of interest rates. Higher deposit rates ahead would stimulate savings and dampen consumption. He asserted that the full magnitude of monetary tightening is actually well over 250bps, if one considers the operative rate of reverse repo as the starting point. He views the (forward) real policy rate being near-neutral already, while Prof. Goyal, who voted for a 35bps hike, also argued that the forward real rate will be approaching 1%. She pointed out that HH expectations are not a good anchor and excessive hikes will not make inflation targeting credible, if they are unable to lower supply-side inflation and instead raise costs as demand and investment falls. She also cautioned that output sacrifice ratios could be considerably high, as the labor market is still in slack, there is no wage-price spiral and second-round demand fears linger on. Amid high uncertainty, gradual data-based action would thus reduce the probability of over-reaction. Prof. Varma also stated that more hikes can be executed later, if needed. However, Dr. Patra (and Dr. Ranjan) asserted that inflation expectations can un-anchor and so immediate focus should be on being time consistent and not a laggard.

RBI unlikely to become too restrictive

While conscious front-loading of policy rates would ideally give the MPC some room forshallow hikes ahead, the fear of consistent repricing of the Fed’s massive hikes is coercing EMs, including India, to follow suit. Although inflation is facing near-term upside risks, it will likely average around the RBI’s estimate of 6.7%. Despite the mild easing in input cost of production, the inflation outlook is fraught with considerable uncertainty, given the volatile geopolitical situation, global financial-market volatility, supply disruptions and unseasonal rains, while resilience in demand could also keep core inflation high. We are tracking October inflation at above 6.3% and expect the H2FY23 inflation to moderate to 6%. As per our revised estimates, the current six month forward real repo rate, while positive, is still lower than RBI’s estimated real neutral rate of 0.8-1%. For now, we still believe that the RBI would practice caution on turning too restrictive. The terminal rate could hover near the estimated neutral real rates, implying future hikes totaling a maximum of ~50bps. But the extent of global disruption will remain key to RBI’s reaction function aheadd at.

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