Over to the RBI

While the Fed has left everyone guessing on future rate hikes, India’s central bank should opt for a pause

rbi, economy
Reserve Bank of India (RBI) is in a much better place since it is dealing primarily with price stability issues with no risks in sight to financial stability. (IE)

Despite the stress in the banking sector, the US Federal Reserve on Wednesday opted to raise the target range for the benchmark rate by 25 basis points, to 4.75-5%, making it clear that tackling ‘elevated’ inflation was its priority. Keeping monetary policy and macro-prudential policy apart, the Federal Open Market Committee (FOMC) has decided to persist with quantitative tightening (QT) even as the government ensures banks have access to liquidity. The Fed clearly does not want to tarnish its inflation-fighting credentials, although it must be aware of the kind of impact the continued tightening would have on the US economy at a time when financial conditions are deteriorating in the wake of the banking system’s problems.

But Fed chair Jerome Powell sounded sanguine on banks despite the recent failure of two mid-sized ones and described the banking system as “sound and resilient”. To be sure, Powell did sound a cautionary note on the recent developments, saying they were likely to result in tighter credit conditions for households and businesses. He went so far as to say they would weigh on economic activity, hiring and inflation—though, to what extent is uncertain. That could be one reason the Fed left unchanged its policy-rate projection for the year-end at 5.13% This leaves room for one more cut, if needed. Powell did not rule out another hike, but next year’s rate projection is 4.3%, which is below 5.1%. While the Fed Chair said officials do not expect to be cutting rates this year, many believe there could be a couple of them.

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Given the many challenges before the Fed with regard to stability in the banking system, and the potential inflationary pressure, the FOMC has left itself enough wiggle room to act as the data on the labour markets or inflation prints could turn adverse. But there seems to have been some fine-tuning or even a softening of the stance and the guidance. The last time around, the Fed had said “additional policy firming may be appropriate”, whereas this time the words used were “ongoing increases in the target rate may be appropriate”. Economists have opined that the potential tightening of banks’ lending standards could have a material impact on the economy and hence might not necessitate any more rate hikes. However, at this time, many believe economic activity is set to weaken significantly—even if there is no full-fledged recession—so that there could be a reversal in policy before 2023 is out.

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Back home , the Reserve Bank of India (RBI) is in a much better place since it is dealing primarily with price stability issues with no risks in sight to financial stability. With commodity prices softening—especially prices of crude oil—the bigger challenge before India’s central bank today is a slowing economy that could crimp demand and lead to more joblessness. Growth forecasts for FY24 now range between the RBI’s optimistic 6.4% and a very worrying 5.3%. The good news is that the dollar index has retreated from its highs and could stay at these levels, taking the pressure off the rupee. That, then,would save the central bank some reserves. Also, with the trade deficit in check, there is not much to worry about on the current account. So, it must now make sure rising interest rates don’t damage the demand environment. Governor Shaktikanta Das has maintained that the RBI’s monetary policies are framed on the basis of local factors rather than interest rate decisions in the US. He must walk the talk.

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First published on: 24-03-2023 at 04:30 IST
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