RBI: Currency outweighs inflation relief for monetary panel for now – Blue Barrows

Mumbai: A sense of relief appears to be emerging on the magnitude of future interest rate increases by the Reserve , thanks to Monetary Policy Committee’s external members Jayanth Varma and Ashima Goyal.

When the conservative Varma suggests repo rate at 6% is good enough for a pause, it’s a sufficient signal that the RBI is close to peak interest rate, for now. After a fourth straight increase, the repo rate is at 5.9%. To add weight to Varma’s stance, Goyal said the MPC may end up overdoing the increases, hurting the economy.

Both argue that monetary policy works with a lag, so it makes sense to take the foot off the pedal and take stock of past increases before delivering the fourth 50 basis points increase. A basis point is 0.01 percentage point.

“If lagged effects of monetary policy are large, as in India, overreaction can be very costly,” wrote Goyal. “Taking Indian repo rates too high imposed heavy costs in 2011, 2014 and 2018. A credit and investment slowdown was aggravated and sustained. It is necessary to go very carefully now that forward-looking real interest rates are positive.”

Varma, who in the past questioned extraordinary monetary stimulus to fight Covid-triggered slowdown, threw a surprise.

“I think the MPC should now raise the policy rate to 6% and then take a pause,” Varma said in the minutes. “A pause is needed after this hike because monetary policy acts with lags. It may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters.”

For her part, Goyal says the real interest rate based on the RBI’s forecast for fiscal first quarter next year could be a positive 75 basis points, or 100 if the repo rate is moved to 6% as Varma suggests.

But there’s a reversal in the role of the MPC members, especially from the RBI that went beyond MPC’s rate easing to revive growth. When external members are for a pause, RBI economists are turning extra vigilant.

“What is disquieting is that inflation stripped of these transitory effects has become unyielding,” wrote Deputy Governor Michael Patra. “The RBI’s forward-looking surveys suggest that selling prices in manufacturing and services may rise further as pass-through from input cost pressures remains incomplete,” which calls for frontloading to anchor expectations, he said.

While Varma-Goyal’s public commentary may be restrained due to the inflation targeting law that specifies only ‘growth and inflation’, Patra’s reference to ‘exchange rate’ now becomes key in monetary policy making.

“Exchange rate volatility (read depreciation) is amplifying these core price pressures, especially in view of key import prices being invoiced in the US dollar,” said Patra.

Currency movements during normal times are determined by the fundamentals of an economy. Now, Federal Reserve Chairman Jerome Powell who threw trillions of dollars for free last year is charging like an Indian money lender, forcing leveraged investors to dump all other assets bought with cheap USD.

Governor Shaktikanta Das describes it as the ‘third shock.’

“The financial and external sectors also continue to be under the Reserve Bank’s close watch,” wrote Das.

What’s happening in the financial and external sectors?

The UK just sacked its finance minister for a fiscal mess. The US and UK treasury bonds are performing worse than risky equities. The S&P 500 has lost more than a quarter of its value. The Japanese Yen is down 30% to the US Dollar.

“There could be even more economic shocks. Financial stability risks are growing: rapid and disorderly repricing of assets could be amplified by pre-existing vulnerabilities, including high sovereign debt and concerns over liquidity in key segments of the financial market,” Kristalina Georgieva, managing director of International Monetary Fund, said ahead of its annual conference where Governor Das and his deputy Patra were present. Their return from such a meeting last time marked the beginning of the rate hike cycle.