The Monetary Policy Committee’s (MPC’s) decision to not raise the policy rate and wait to assess the impact of the effective 300 basis points of tightening is justified, given that inflation this fiscal is estimated to average 5.2% and is not expected to breach 6% in any quarter. The FY24 growth forecast of 6.5%, however, was surprising as the consensus estimates are much lower, at about 6%, with some looking at even 5.5%. Some of this is reflected in the MPC’s assumptions for crude oil prices, which have been pruned to $85/barrel. The central bank paused probably because it is now concerned about growth, which is lower than 7% in FY23.
Several factors have helped the MPC make this decision. First, inflation is now seen to be tapering off to 4.5% in FY25. That seems to be good enough for the Reserve Bank of India. Indeed, hitting a 4% inflation at the cost of growth would not be worth it. Second, real rates are at around 130 basis points. Third, the rupee has been steady and it seems unlikely the dollar will strengthen too much. In fact, there is little worry about the external front, with the current account deficit (CAD) likely to be reined in at around 2%of GDP this year. Fourth, with most global central banks expected to slip into a pause later this year (some of them have already gone that path), rate differentials will play a smaller role.
As RBI Governor Shaktikanta Das has put it, the environment is “daunting”. The production cuts by Opec+ together with the revival in China could send oil prices sharply higher. Back home, inclement weather could hurt the harvest pushing up food prices. And core inflation remains “unyielding” as companies continue to pass on the higher cost of inputs. That’s probably why the stance has been left unchanged at “withdrawal of accommodation”—it certainly gives the central bank room to manage rates. However, as the Governor observed, and this newspaper has argued, it is necessary to evaluate the cumulative impact of the effective 300 basis points of tightening. Deputy Governor Michael Patra pointed out that credit flows are slowing, especially to rate-sensitive sectors. The recovery post the pandemic has been K-shaped and, hence, growth cannot be allowed to slow to a point where it is difficult to push it up again.
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While Governor Das stressed the point that this is a pause and not a pivot, this seems intended to give the MPC wiggle room for any exigency and to let the markets know that, in this uncertain world, about-turns are possible. However, if the MPC isn’t hiking after two straight 6%-plus inflation readings, it is unlikely it will when inflation is trending down. In that sense, the bar for a rate hike is now higher. Right now, therefore, it looks like 6.5% could well be the peak rate unless, of course, there are significant disruptive events that pressure the capital account, the balance of payments and the currency. That’s the reason the bond markets are celebrating; they don’t expect a hike unless the Fed hikes more than anticipated. Given the Centre’s large borrowing plans, yields—especially at the longer end—will trend up, but the bond markets are in good humour. They won’t mind even if rate cuts come in only when there’s greater certainty on price stability.
