What to expect from the August RBI Monetary Policy

The Monetary Policy Committed (MPC) of the RBI will meet between 03rd August and 05th August and it will culminate in the presentation of the monetary policy on Friday. Before getting into the expectations of the policy, it is essential to understand the backdrop in which the RBI will be presenting its monetary policy. It is at a time when inflation continues to rule high and industrial inflation continues to put pressure on the operating margins of Indian companies. On the positive side, oil prices have tapered lower.

Key background to the Monetary Policy, August 2022

Here is the macro situation as the RBI prepares to present the monetary policy on 05th August. 

    • The Indian CPI inflation has tapered close to 7% but WPI inflation or producer inflation still remains elevated at above 15%.

    • The RBI has already hiked rates by 90 basis points between the May and June MPC meetings. In addition, the RBI has also hiked the CRR by 50 basis points.

    • Inflation in the US, however, continues to be at fairly elevated levels with consumer inflation being reported at 9.6% (a 41-year high) for the month of June 2022.

    • Fed has hiked rates in the US by 225 basis points since March of which 150 bps rate hikes has been done in the months of June and July alone.

    • Therefore, RBI has to consider monetary policy divergence risks, real rate risks and the risk of capital outflows while setting the policy in August.

    • While the RBI has committed itself to price control, above all else, it may not be willing to forsake growth; being the fastest growing large economy in the world.
It is in the above background that the RBI would present its monetary policy in August and this milieu will broadly determine how much the RBI would be willing to hike rates.

What to expect from the August 2022 RBI policy?

It is not just the US Fed that is hiking rates today. The Bank of England has been hiking rates quite aggressively to control inflation and in the lates meeting in July even the European Central Bank (ECB) has hiked rates by a surprising 50 bps. Here is what to expect in the August 2022 policy announcement.

    a) With imported inflation still a risk for India, and the Fed talking of another 75 bps rate hike in September, the RBI would not be taking chances. A rate hike in the range of 35 bps to 40 bps looks likely, although it may veer towards a round figure of 50 bps.

    b) In a recent report, CRISIL has pegged food inflation to remain closer to 7% through FY23. That is likely to impact the RBI inflation estimates. Delayed monsoons and uneven distribution this year are likely to negatively impact the Kharif output.

    c) During the COVID peak the RBI had cut rates by a total of 115 basis points. As of now only 90 bps have been reversed by the RBI and it will take another 25 bps to take the rates back to the pre-COVID levels. Considering the CPI inflation consistently above the 6% tolerance limit, RBI may look to take rates beyond pre-COVID levels.

    d) While it is not clear if this would be the terminal rate hike, the EBLR has ensured that pass through is almost immediate. This is likely to have a bearing on the way the RBI decides at what point to conclude the rate hike cycle.

    e) The RBI has pegged full year inflation for FY23 at 6.7% and it remains to be seen if it decides to drag this estimate closer to the 7% mark. However, with commodity prices sobering, the RBI may choose to wait for a couple of more months.

    f) The market consensus is of a terminal rate target of 5.75% in this cycle, assuming that inflation normalizes soon. However, the RBI would be conscious of the fact that sharply higher rates may raise the government cost of borrowing as also for corporates.

Outside the ambit of rate hikes, one major expectations is that the RBI may again announce a slew of measures to enhance dollar flows into India and reduce the pressure on the forex reserves, especially in the light of the burgeoning trade deficit. It remains to be seen if the RBI also resorts to other accretive and preventive strategies. This could include measured trade restrictions, INR settlement of external trade, flexibility to banks regarding NRI deposits etc. The non-monetary policy measures could be rather interesting in August.