September to be MPC’s final hike in current cycle

India’s inflation outlook appears more manageable to us at this time, as concerns over disparate rainfall distribution are negated by high buffer stocks of food grains. Only if drought-like conditions extend into 2023 do we see a strain on the level of rice reserves. The ongoing currency depreciation could prevent some of the benefits of globally cheaper commodities from being passed on to retail consumers. We are also witnessing a faster revival of pricing power on the domestic front, especially with services firms, which could pose risks to the CPI outlook in the coming months.

While India’s macroeconomic backdrop has improved, headwinds do appear to be building in the context of the global economy. The MPC may not formally acknowledge external financing-related issues. A persistent negative terms-of-trade shock and export tariffs have pushed trade deficits to unprecedented levels. This is a situation that leaves us vulnerable to a widening current account deficit at above 3.0%, which is the watermark that has traditionally been regarded as the sustainable level for the Indian economy. While capital inflows have resumed, they may not be sufficiently large in the near term in order to address burgeoning funding requirements, and therefore, a heavy drawdown on RBI’s forex reserves remains very likely. While the inclusion of India Government bonds in global bond indices remains a possible and key silver lining, it will likely come to be only in FY23-24.

Major central banks remain competitively hawkish in their determination to temper inflation, and in doing so, they have also signalled their willingness to hike rates, even risking prospects of a recession.

Either reluctantly or of their own volition, emerging markets’ central banks feel compelled to be in tandem with the Federal Reserve in tightening monetary conditions or risk a sharp depreciation in the value of their currencies. While Indian fiscal and monetary policy interventions have so far ensured limited disturbance for the country, the somewhat depleted foreign exchange reserve chest and fiscal space constraints indicate that monetary authorities will be cognizant of the possibility of increased vulnerability for India from future shocks. The recent weakness in INR, driven primarily by a stronger dollar and weaker global currencies, will indeed be a prime area of focus, and we expect RBI to acknowledge risks from this dynamic in their policy thinking and even actions.

The deteriorating global backdrop could bring risks of a wider current account deficit, a stickier fiscal deficit profile, and inflation running higher than average over the cycle. While RBI has predominantly deployed an inflation-reduction strategy thus far, we believe it will also not lose sight of broader macro imbalances that are set to evolve over the coming years.

Against this backdrop of relatively resilient growth and slowing, though above-target, inflation, we expect the MPC to continue on its path of front-loaded tightening with a 50bps rate hike, and change its policy stance to neutral.

Despite the upside surprise in August’s CPI print, we continue to track CPI below RBI’s forecast trajectory and, as a result, see real rates in India moving closer to the desired levels. As a result, we see the September policy meeting delivering the terminal hike in the current cycle and see little need for further monetary tightening from the MPC. Transmission of the cumulative 255bp hike (including the September 50bp) will now gain precedence as the MPC pauses and observes the impact of past actions on growth-inflation dynamics.

India’s economy is on a more stable footing than those of many countries at this time, and, in our view, given the resilience in domestic private consumption, with gathering investment momentum supported by cleaner balance sheets and government capital expenditure, India should easily manage a substantive 6%-7% growth over the next few years.

Rahul Bajoria is managing director and head of EM Asia (ex-China) Economics at Barclays. Views are personal.

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