Monetary policy: headed for a pause :: IIFL

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Monetary policy: headed for a pause
Pause—not end—to tightening cycle: After a 25bps hike in policy
rates on 2 November, we expect RBI to take a pause in its calibrated
policy-tightening stance. However, we expect RBI to only pause, and
don’t believe this to be necessarily the ‘end’ of policy tightening, as
inflation—both in goods and real assets (real estate)—is high. We believe
RBI will pause as long as inflation continues to track its projected
trajectory (6% WPI by March) and asset markets do not show an
abnormal rise. Consequently, rates could go either way after the pause—
up if inflation worries do not abate, down if growth worries surface.
Pause by RBI, but transmission to pick up: The effective operational
policy rate has already moved up by 275bps (including the shift in
operating rate from reverse repo to repo rate) since March, when RBI
first raised its policy rates. Further, RBI has already indicated that the
monetary policy has normalised and future rate actions would depend on
inflation vs. growth outlook. Monetary policy affects the real economy
with a lag, especially in India, where monetary transmission is weak.
With signs of monetary transmission picking up, we think it is reasonable
for RBI to pause, and keep liquidity tight, so that monetary transmission
continues. Consequently, though we expect RBI to pause, banks which
have hiked their base rate by ~25-50bps in the recent few weeks, will
likely hike lending rates by another 50-100bps till March.