Multiple challenges to RBI's unchanged GDP forecast of 7.2%

The Reserve Bank of India's (RBI) projection of retail inflation or consumer price index (CPI) at 6.7 per cent for the entire year 2022-23 puts the real GDP projection, which is retained at 7.2 per cent, under question. There is likely to be a downward revision in the forthcoming monetary policy committee (MPC) meetings. There are actually multiple challenges to growth in the months ahead. Let's take a look.

More interest rates hikes are coming

The primary objective of RBI's monetary policy is to maintain price stability (inflation control) while keeping in mind the objective of growth. It is a well-known fact that low and stable inflation is a prerequisite for long-term sustainable growth in the economy. Currently, the RBI's own retail inflation projection for CPI is at 6.7 per cent for 2022-23. The inflation target for the monetary policy committee (MPC) is at 4 per cent with an upper band of 6.0 per cent. Clearly, the RBI is in breach of its target. This kind of higher inflation will require more doses of repo rate hikes. There are now expectations of a further 75-100 basis points hike in the repo rate from 4.90 per cent.

Given the global crude prices at $120 per barrel, rising commodity prices, and a depreciating rupee against the US dollar, the upside risk to current inflation (6.7 per cent ) is very high. Higher interest rates are not good for the economy, especially corporate, private equity funds, portfolio investors as well as retail borrowers. It will impact the current economic recovery which is underway. RBI Governor Shaktikanta Das today said that in an extremely uncertain situation and conditions,  the future (rate ) action will depend on the evolving dynamics.  He, however, listed out upside risk to inflation from higher global commodity prices, supply-side issues, pass-through of higher prices from companies to consumers, and elevated international crude oil prices.

Surplus liquidity in the system to fuel inflation

The monetary policy uses the twin tools of controlling the volume of money (liquidity in the system) as well as the price of money (repo rate) to adopt an expansionary or a tightening credit policy. The RBI has now entered the tightening cycle by way of an increase in the cost of the money to control inflation. But the volume of money is still in surplus mode.  The RBI's stance is still accommodative. The current daily surplus liquidity is of the order of Rs 7 lakh crore, which is very high.  During the pre-pandemic days, the surplus liquidity was to the tune of Rs 2.5 lakh crore.

Any economist would tell you that the monetary policy is generally effective if the liquidity in the system is either in neutral or deficit mode. RBI under Das is trying to find a balance by continuing to support the growth or recovery of the economy. "We are completely focussed on withdrawal of accommodation. The surplus liquidity is higher than the pre-pandemic level. The liquidity withdrawal going forward would be calibrated," said Das in the media conference. The RBI Governor has recently said that the central bank will normalise surplus liquidity over a multi-year time cycle of 2 to 3 years. "All that we want to convey is that we do not want to take abrupt action," said Das. But this surplus liquidity at a time when there is not enough demand for credit is expected to influence the inflation trajectory in the upward direction.

Capacity utilisation is still low to attract fresh investments from India Inc

The RBI Governor has said that the capacity utilisation in the manufacturing sector has increased from 72.4 per cent in the third quarter to 74.5 per cent in the fourth quarter of 2021-22. "Capacity utilisation is also likely to increase further in 2022-23. Investment activity is thus expected to strengthen, driven by rising capacity utilisation, government’s Capex push and deleverage corporate balance sheets," said Das. But the current capacity utilisation levels are not high to attract fresh investments from the corporate sector. The capacity utilisation levels have to reach 80-85 per cent plus across sectors to invite interest from the companies.

Govt capital expenditure to face budget constraints

The government's capital expenditure is the only engine that is firing on all cylinders for the last 2-3 years. The government has budgeted a record Rs 7.5 lakh crore Capex for 2022-23. There is also an assumption that the govt Capex will fuel private Capex at some stage in the near future. But the budget numbers will now face challenges from higher inflation. Take for, example, the recent excise cuts in petroleum and diesel will result in a revenue loss of over Rs 1 lakh crore. There is likely to be further pressure on the government to reduce excise duties as global crude prices are still ruling at $120 per barrel. The RBI's assumption for 6.7 per cent inflation is based on crude at $105 per barrel. In addition, the higher input cost is going to impact the margins and profitability of the corporate sector, which in turn, would impact the corporate tax collection.