In December, the US Federal Reserve is also expected to raise interest rates by 50 basis points, down from a previous prediction of 75 basis points.
Stock markets recently rose as a result of remarks made by US Federal Reserve Chairman Jerome Powell, who said that the Fed would slow the pace of tightening monetary policy at its upcoming policy meeting on December 13 and 14. The Reserve Bank of India’s Monetary Policy Committee (MPC) may also choose to raise the policy interest rate slightly before the US Federal Reserve meeting, which takes place on December 5-7.
How likely is it that there will be a US Federal Reserve?
In December, the US Federal Reserve is expected to increase main interest rates by 50 basis points, down from a previous prediction of 75 basis points. Many analysts believe that the drop in the US Consumer Price Index, which went from 8.2% in September to 7.7% in October, is what has slowed interest rate increases. A 2% inflation rate has been the Federal Open Market Committee’s (FOMC) target for years.
Since March of this year, the US Fed has also raised interest rates by 3.75 percentage points. Interest rates increased by 75 basis points at each of the most recent four meetings, which occurred between May and November 2022.
Powell recently stated in a speech that the full effects of our recent rapid tightening have not yet been felt and that the effects of monetary policy on the economy and inflation have unknown lags. So it makes sense to slow the rate of rate increases as we get closer to the level of restraint required to reduce inflation. He stated on November 30 that “the time for moderating the pace of rate which increases may come as soon as the December meeting.”
Fed Governor Michelle Bowman also hinted on Thursday at a more gradual rate increase, similar to the Fed President.
What steps will be taken by the RBI?
Economists estimate that retail inflation decreased to 6.77 percent in October from a high of 7.41 percent in September. The RBI is expected to raise the repo rate by 25 to 35 basis points in the upcoming monetary policy.
According to a recent research report by Nomura, while Q2 FY23 GDP growth surpassed the RBI’s forecast of 6.3%, core inflation persisted, forcing the RBI to continue raising rates, albeit more gradually. “Our base case envisages a downshift to a 35 bps hike at the December 7 meeting, followed by a final 25 bps hike in February, although the latter is a close call,” the statement reads.
Between May and September, the RBI raised interest rates by 190 basis points, from 5.90% to 5.90%. The RBI raised the repo rate by 50 basis points in each of the previous three policies in an effort to reduce inflation.
What a Federal Reserve decision will do?
Analysts believe that the US Federal Reserve’s decision to raise interest rates will have an impact on capital flows to emerging market economies like India. The current interest rate in the US is 3.9%, compared to 5.9% in India. As a result, there is a 2% difference in interest rates between the US and also India. If the US Federal Reserve also raises interest rates by 50 basis points while the RBI maintains its rate, the interest rate spread will narrow to 1.5%, making India less attractive to foreign investors.
The United States, the largest capital exporter in the world, frequently transfers sizable sums of money to developing market economies. According to a foreign exchange expert, interest rates need to be increased in order for India to attract investments and increase its foreign exchange reserves.
Since they were still focused on assisting economies that had been severely damaged by the pandemic, central banks chose to ignore inflation when it first began to surface a year ago, characterising the price increases as temporary. But as it became clear that the inflation would persist for a longer period of time, central banks were forced to make a quick course correction, drain the system of excess liquidity, and sharply raise record-low interest rates this year.
The US Federal Reserve declared on Wednesday that interest rates would increase by an additional 75 basis points. The benchmark Fed Funds rate rose by 0.75 percentage points over four consecutive increases, reaching its highest level since 2008. The Fed has not tightened monetary policy at this rate in almost 40 years.
The move is not unexpected given that US inflation is currently hovering around 8%, significantly higher than the Fed’s target level of 2%. The EU and the UK are just two markets that share this situation. For instance, the Bank of England has raised interest rates seven times since December, and another rate increase is expected at its upcoming meeting on Friday.
After its most recent meeting, the Federal Reserve announced that further increases in borrowing costs would be required to combat inflation. However, the inflection point may be near, indicating that subsequent rate increases may not be as sharp.
Increases in interest rates in the developed world, particularly those made by the Federal Reserve, have a significant impact on India and other emerging market economies. Inflation and uneven post-pandemic growth are issues in these countries as well. Rising interest rates have also compelled central banks, like the Reserve Bank of India, to consider them when making policy decisions in developed markets.
This fiscal year, the rupee has lost more than 7% of its value against the US dollar, and foreign portfolio investors have already withdrew more than Rs 1.64 lakh crore from India’s capital markets. As long as there is global geopolitical and economic unpredictability, investors tend to look to the safety of the dollar. The rupee will weaken even more as a result of the ongoing dollar outflows, which will hurt importers as well.
Nevertheless, the monetary policy committee of the RBI met today without prior notice. It was intended to draught a response to the government regarding the issue of high inflation.
Inflation measured by the consumer price index (CPI) grew to a five-month high of 7.4% in September. By law, the RBI must explain to the government why it has failed to bring inflation to the desired range of 2% to 6% for three consecutive quarters, as well as the main steps it has taken to address this failure.
The Reserve Bank of India didn’t begin raising interest rates until a hurried meeting in May of this year. Since then, it has added 190 basis points to the benchmark repo rate, which is the price at which it lends to banks. Nevertheless, inflation continues to exceed the Reserve Bank’s upper tolerance band.
RBI Governor Shaktikanta Das defended the organization’s response on Wednesday at a gathering sponsored by the Indian Banks Association and the business association FICCI, saying “it had prevented a complete downward turn of our economy.” Premature action, he continued, would have cost the people of this country “very dearly.”
Given that this is a private conversation between the two parties, the central bank is not likely to reply to the government right away.
The RBI’s response suggests that supply-side issues and Russia’s invasion of Ukraine may be to blame for the high inflation. According to Das, the evaluation performed in January and February of this year indicated that the average inflation rate was likely going to trend around 5%. However, everything was altered when the February Russia-Ukraine war started.
After the MPC meeting in December, there will almost certainly be another rate increase.
Right now, the repo rate is 5.90%. According to executives at HDFC Bank, the RBI will probably raise the repo rate to at least 6.50 percent or higher as “providing currency defence becomes prominent on the RBI’s agenda.”
According to Goldman Sachs analysts, the RBI may raise the repo rate by 35 basis points in December and another 50 basis points later, bringing the benchmark rate to 6.75 percent by April 2023.
The US Federal Reserve has also increased interest rates by 75 basis points (bps) since the outcome of the most recent Reserve Bank of India (RBI) policy in September 2022, and is expected to raise rates by an additional 50 bps in December 2022. Jerome Powell, the governor of the US Federal Reserve, recently made some remarks that were less hawkish than those of other Fed governors, and as a result, the expected terminal interest rate dropped from 5 to 5.25 percent to 4.75 to 5 percent.
The Dollar Index has decreased from 112 levels to 104.50 as of December 2, 2022, despite the US rate increase in November 2022 and also the incremental rate hike anticipated moving forward. The 2/10-year interest rate yield curve has further inverted from 40 bps to 80 bps, and US 10-year yields have dropped from 3.8 percent to 3.5 percent.
The yield curve for interest rates is inverted, which indicates that the US rate hike cycle will be brief. The USD-INR has also increased since hitting a low of 83 rupees to the dollar in mid-October. Recently, the risk to financial stability has decreased as well, and a rate increase is no longer necessary to manage it.
The making of monetary policy was described by Michael Patra, deputy governor of the Reserve Bank of India, in a recent speech titled “The lighter side of Monetary Policy.” “Monetary policy is a technical area of economic policy-making by its very nature. Due to the lags in the transmission of policy rate changes across markets and their eventual reflection in lending rates, mortgage rates, and yields, monetary policy must be forward-looking. Therefore, rather than addressing the inflation of today, monetary policy can only hope to address the future,” he said.
Patra continued, “At any point in time, the monetary policy maker is not always able to see the goal variables of inflation and growth. Future projections are largely based on data from one to three months ago that is looking backwards. As a result, they risk being detoured by unplanned shocks that occur in the future. In order to predict the likely future course of the goal variables, monetary policy makers in this difficult situation sift through a sea of information (technical, economic, analytical, financial market indicators, etc.).
With the exception of the current fiscal year, the RBI has been largely accurate in predicting growth and inflation estimates over the past few years (FY23). RBI was required to write a letter to the government outlining the causes of the inflation target being missed for three straight quarters. According to our opinion, the RBI should continue to make monetary decisions based on its future estimates without questioning its own estimates.
As predicted by the RBI, real GDP increased by 6.3 percent in Q2FY23. According to growth projections for FY23, which are set at 7%, second-half growth will be between 4.75 and 5%. In FY24, growth is probably going to be less. Market forecasts place growth for FY24 in the range of 5.5–6%. Market estimates are 50 basis points lower than RBI growth projections.
For the month of October 2022, inflation was 6.8%, which is lower than it was for the previous monetary policy. The Consumer Price Index (CPI) may gain with a lag if the Wholesale Price Index (WPIsequential )’s momentum continues to decline. By Q1FY24, inflation is most likely to gradually trend downward and fall within the target range set by the RBI. The RBI has estimated Q4FY24 inflation at 5.2 percent.
Dr. Ashima Goyal, a member of the Monetary Policy Committee, highlighted the need for a real rate of 100 bps in a recent interview.
Since the system’s liquidity has decreased from April 22 through December 2022, and since deposit growth has lagged behind credit growth, this is also likely to put pressure on lending rates in the future.
We anticipate a 35 basis point increase in the repo rate at the December 2022 MPC meeting, bringing the repo rate to 6.25 percent, in light of the RBI’s estimates for Q4FY24 inflation, lower growth expectations for FY24, declining financial risk, and a cumulative increase of 300 basis points in overnight rates since April 2022.
We also think it makes sense for RBI to switch its stance on monetary policy from “withdrawal of accommodation” to “neutral,” which implies that rate actions in the future will depend on data.
edited and proofread by nikita sharma
