'Not suggesting next policy move is a hike, but there is a need to relook'

RBI MPC member Saugata Bhattacharya says the repo rate may need reassessment if inflation broadens, but current data does not warrant a rate-hike cycle

The markets were surprised by the hawkish commentary from the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) last week since the August policy was being viewed as dovish. While explaining how the market missed the message for a need to recalibrate policy rates, Saugata Bhattacharya, external member of the MPC, during an interaction with Manojit Saha in New Delhi, says the cost of policy action and not falling behind the curve in controlling inflation must be balanced. Edited excerpts:

 

The MPC minutes have been interpreted as hawkish by the market. Was there a conscious effort in the policy communication, as well as in the MPC minutes, to prepare markets for an eventual rate hike? 

These comments are my personal views, I do not speak on behalf of the MPC. 

In the MPC resolution, paragraph 12 states that any policy action “would have to consider the need for recalib­ration of policy rates in line with the evolving growth-inflation dynamics, especially the normalisation of the underlying inflation from its [earlier] benign levels”.  To my mind, this, read in conjunct­ion with the forecast headline CPI inflation averaging of 5 per cent in FY27 and the path going up to 5.9 per cent in the third [quarter], should have signalled that there might be a need to re-look at the policy rate of 5.25 per cent. I am not suggesting that the next policy move is a hike, but there is a need to relook. 

A balance had to be struck between the economic cost of taking action at this point against the need not to fall behind the curve in control­ling inflation and anchoring inflation expectations. My judgement was that this was not the time to make any change in the policy rate. We would get two further inflat­ion prints to figure out wheth­er inflation was actually bec­oming generalised, whether the month-over-month mom­entum was increasing. 

An update of Q1 GDP data will also help to assess consumption and investment, and help to infer purchasing and pricing power. If there are signs that inflation is getting persistent, and the growth-inflation balance shifts, then the MPC might have to recalibrate.

 

In this context, what are your views on sequencing the stance and rate action? Do you think both can happen simultaneously, or will the stance change happen before a rate hike? Hypothetically, can the MPC hike the rate without changing the stance from neutral? 

There is nothing sacrosanct about any particular sequence of steps. The neutral stance allows flexibility to change the policy rates at the appropriate time, depending on the expected evolution of the growth-inflation balance. 

At the August review, my vote to hold the repo rate was based on my assessment of the then (and forecast) macro-financial conditions. I deemed the present repo rate appropriate in balancing the economic costs of early policy tightening weighed against the risk of inflation getting persistent. 

I do not have enough information at this time to commit a priori to a path for the policy repo rate. I will need to monitor new data releases and updated forecasts before taking a call on next actions.  The projected 6.7 per cent growth still remains more or less resilient in this global environment, while other indicators, tax collections, etc., suggest that demand momentum is sustaining. 

Again, I don't want to lock myself into a pre-committed rate path in such a fluid environment. If we shift from the current neutral stance to a more restrictive, tighter stance, that automatically commits you to a certain trajectory. Even if economic conditions at the October review warrant policy tightening, I will be cautious about changing the stance, since that will imply a degree of commitment, which might be warranted only by strong and widening price pressures, and evidence of inflation expectations becoming unanchored. 

Let me emphasise, a comment on a potential need to recalibrate does not mean we are entering a tightening interest rate cycle. At this point, given a forecast of 5 per cent CPI inflation, 5.25 per cent probably looks a little more accommodative than the appropriate level to deal with 5 per cent inflation. Tightening would imply a sequential rate increase, and I don't think the situation calls for that yet. I think we need the flexibility right now to monitor incoming data.

 

Since you referred to ‘real interest rate’, RBI came out with a paper some time back saying that the real interest rate should be around 140 to 190 basis points (bps). In this context, do you think the current rate is too accommodative, and where do you see the terminal rate in the current cycle? 

Real interest rates are potential signals of current policy being restrictive, neutral or accommodative. However, the real natural or neutral interest rate (against which the current and projected real rates have to be measured) is a theoretical construct, and very time and context contingent, depending on estimates of potential output, etc. These constructs are best interpreted in a steady state and not during cycle shifts. 

Given these caveats, the projected track of inflation over the next four quarters argues for a re-look at the appropriateness of the current repo rate. At the same time, as cited before, a premature recalibration might impose significant economic costs, given the continuing external uncertainty. What that level is, and when it will need to be raised, is difficult to predict at this point. Central banks all over the world are just monitoring data and taking action based on it. 

On the other question, the 140-190 bps real natural rate that you mentioned is actually based on the 90-day T-bill rate, which is considered the risk-free rate, and is typically, in a steady state, 30-35 bps above the repo rate. 

Given that, if inflation begins to bite, if there are signs that inflation is becoming more diffused in the CPI basket, then as a first step you probably need to move the policy repo rate to a somewhat higher level.

 

Credit growth has been extremely healthy at 18 per cent and above. From the numbers and figures that are coming in, do you see any signs of overheating in any sector? 

Certain metrics and trends indicate that private sector investments are picking up. Manufacturing capacity utilisation in the last RBI survey was up above 77 per cent. Bank and non-banking financial company (NBFC) credit to the commercial sector has become more broad based across sectors, as well as across small, medium and large enterprises. Commercial real estate is doing well, including data centres. One of the reasons for pausing at the August review was to reduce the risk of economic costs of a pre-mature recalibration. 

However, signs of an overheating of economic activity are still relatively muted. Although difficult to gauge, I believe there is still some residual slack in capacity, but this can close quite rapidly. However, as I have noted before, in the July CPI inflation prints (which were released post the August review), there are signs of a broadbasing of price pressures in the core items. This needs to be monitored closely, as signals of enterprise pricing power and household purchasing power.

 

Given the robust inflows from Foreign Currency Non-Resident (Bank) or FCNR (B) deposits, do you think we can have a positive balance of payments (BOP) situation this financial year? We had a BOP deficit for the last two years, do you think we'll be better off this time? 

The RBI governor’s statement had noted the current account deficit (CAD) being comfortable, sustainable, etc. FCNR (B) and other capital inflows will help. But given the uncertainties on tariffs, energy prices, supply chains, logistics, the overall external balance needs to be closely monitored. The Government of India, in collaboration with the RBI and other regulators, has proactively taken steps to increase stable, long term capital flows. The measures to boost merchandise and services exports will also help reduce our CAD.