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Widening dissent

* The minutes of the December MPC meeting reflected further widening divergence among MPC members on the future rates trajectory. While Prof. Goyal revealed her preference for a 25bps hike (albeit chose +35bps), Prof. Varma explicitly called for a pause. Both the doves suggested caution in getting restrictive on rates amid an uncertain growth environment and argued that monetary policy lags should be kept in mind. Their views make us believe the next policy could see a 4-2 split on policy rates.

* While persistent inflation narrative saw coherence among some members, a few diverged on the policy reaction to the same. Dr. Patra and Dr. Ranjan asserted that inflation expectation could get unmoored and the second-round effect would imply a higher output sacrifice ratio later. In contrast, Prof. Goyal believed India has limited evidence of demand-led inflation and supply components of core are easing. Prof. Varma argued that the current policy rate is sufficient to glide inflation back to the target and growth may incrementally get more weightage in global policy reaction functions ahead.

* We are closely watching consistent global policy repricing, global pace of inflation evolution, and how the impending recession will shape DM central bank’s policies, which could have implications on India. Besides, the inflation outlook is fraught with uncertainty. The RBI is still some distance away from its estimated forward real neutral rate of 0.8-1.0% (keeping 6M ahead inflation as an anchor), even as the forward real repo rate is already positive. We reinstate the RBI may not turn too restrictive, implying hikes of not more than ~25bps ahead. However, we reckon the situation is fluid and might require frequent adjustments in policy assessments ahead.

MPC split gets more acute

The minutes of the December MPC meeting, which saw a slower hike of 35bps with a 5-1 split (Prof. Varma voted for a pause), depicted a cautious and data-dependent tone, with most members anchoring their arguments to the risk of sustained high inflation and their second-round effects. The divergence in the view became even more acute this time. Dr. Patra and Governor Das were significantly hawkish, while Dr. Ranjan and Dr. Bhide seemed cautiously neutral. Prof. Varma and Prof. Goyal sounded more dovish than October minutes and voted against the “withdrawal of accommodation” stance. Their views make us believe that the next policy could see a 4-2 split on policy rates, with both calling for a pause. In fact, Prof. Goyal stated she would have preferred a 25bps hike but still voted for a 35bps hike as 6.25% acts as a better focal repo rate. Prof. Varma asserted the full magnitude of monetary tightening is actually well over 290bps and one has to account for policy transmission lags – a view that Dr. Goyal shared as well.

Inflation concerns see varying views

The extent of inflation concerns seemed to be a tad varying. Both the doves argued the Brent assumption of $100/bbl is debatable while forecasting the inflation ahead. Prof. Varma asserted global inflation seems to have peaked and is now probably heading lower, while the producers’ pricing power and consequently the profitability has eroded dramatically. Prof. Goyal argued Indian supply chain pressures have been easing, business inflation expectations are anchored, and supply disruptions in core inflation are now correcting. Dr. Patra and Dr. Ranjan believed the stickiness of core inflation and sustained high inflation could unmoor inflation expectations and lead to second-round effects. Dr. Patra would need to see a fall in "series of monthly inflation readings" to change his stance – unlikely by February meeting. Governor Das agreed with the view, suggesting a pause at this juncture would be premature. Four of the six members also highlighted risk to growth, with a few cautioning against a high sacrifice ratio due to increased rates.

Continued debates around EM/India risk premia, the current and forward real rates

Prof. Goyal argued that the risk premia for India vs. US are significantly higher than the average EM risk premia, which effectively implies a larger demand-reducing effect. She felt the expected real rate is positive and close to the equilibrium rate. Dr. Ranjan asserted the terminal rate is time-varying when the monetary policy is clouded by uncertainty on the strength and direction of growth and inflation impulses. He stated while real rates have moved decisively towards the positive territory, forward real rates could remain tricky amid increased inflation uncertainty. Besides, bank deposit and lending rates in real terms are much lower than pre-pandemic levels. Governor Das argued explicit forward guidance on the future path of the monetary policy would be counterproductive in an uncertain environment.

Scope for another shallow hike of 25bps

Forward real rates are still sub-1% – RBI's estimated real neutral rate – keeping six-month ahead inflation as an anchor, implying space for another shallow hike of up to 25bps (albeit not necessarily implying the end of the cycle). We see FY23 inflation averaging ~6.6%. At this point, we still think the RBI would not turn too restrictive; however, the extent of global disruption will remain key. We are closely watching the global pace of inflation deceleration and how the impending recession will shape DM central bank’s policies, which could influence the RBI. While global disinflation is imminent, the near-term price stickiness is still keeping disinflationary path non-linear. (See: Macro Strategy; Too early to have one’s day in the sun?). Thus, the still-fluid global situation might require frequent policy adjustments

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