RBI soft-pedals on rate hikes, but may not have hit the brakes yet

The Reserve Bank of India (RBI) on Wednesday raised the policy repo rate by 35 basis points (bps) to 6.25%, downshifting gears from consecutive increases of 50 bps, and scaled down GDP growth hopes for the year to 6.8% from 7%, even as Governor Shaktikanta Das exuded confidence about the economy being resilient and asserted that “the worst of inflation” was behind us.

A 100 basis points equal one percentage point. The central bank retained its inflation projection for 2022-23 at 6.7%, noting that inflation will ease but stay well above the 6% upper tolerance limit set for the RBI.

Mr. Das vowed to keep an “Arjuna’s eye” on evolving inflation dynamics, even as cooling global prices for crude oil, commodities and other items extend hope of relief.

Having hovered well over RBI’s upper tolerance limit of 6% since January 2022, retail inflation eased slightly on a sequential basis to 6.8% in October, but Mr. Das noted that core inflation remains sticky and the medium-term outlook “is exposed to heightened uncertainties from geopolitical tensions, financial market volatility and the rising incidence of weather-related disruptions”.

RBI Deputy Governor Michael Patra said the moderation of inflation will be “very grudging, very uneven” so the central bank must first “shepherd inflation firmly into the tolerance band (below 6%) and then to the 4% target”.

The RBI now expects inflation to average 5.9% in the January to March 2023 quarter, drop to 5% in the first quarter (Q1) of 2023-24 and edge up to 5.4% between July and September 2023, assuming a normal monsoon.

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The central bank believes that the economy is “resilient” with the Q2 of 2022-23 clocking 6.3% GDP growth, in line with its estimate, and economic activity gaining further strength in October bolstered by urban consumption and a recovery in discretionary spending.

However, it expects GDP growth to wane to 4.4% in Q3 and 4.2% in Q4 owing to adverse spillovers from the global slowdown and its negative impact on India’s exports and overall economic activity.

“The biggest risks to the outlook continue to be the headwinds emanating from protracted geopolitical tensions, global slowdown and tightening of global financial conditions. Real GDP growth is projected at 7.1% for Q1 of 2023-24 and at 5.9% for Q2. Even after this revision in our growth projection for 2022-23, India will still be among the fastest-growing major economies in the world,” the monetary policy statement noted.

The six-member monetary policy committee was, however, not unanimous about the latest policy stance, with one member voting against the rate hike and two members disagreeing with the decision “to remain focussed on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”.

Mr. Das left it to the market to interpret if the policy was ‘hawkish’ or ‘dovish’ and was non-committal about this hike marking the end of the current rate increase cycle that has lifted the policy rate from 4% in April to 6.25%.

Mr. Patra, however, pointed out that the moderation in the pace of rate hikes “after continuous 50 basis points increases” indicates a “shift in the wind”. “If things pan out as we have projected, then the 50-basis point consecutive increases in the rate are over,” he said, adding that the central bank can still not take its shoes off the pedal as inflation needs to be guided lower and stabilised.

Asserting that India’s monetary policy is determined primarily by domestic factors, Mr. Das, however, noted that the “terminal rate” for the U.S. Federal Reserve, which has raised interest rates by 3.5 percentage points over the same period and whose actions affect global financial conditions, is “anybody’s guess”. But they cannot be tightening monetary policy “endlessly”, he remarked.

“When the tightening is over, the tide will surely turn. Capital flows to India will improve and external financing conditions will ease,” the Governor said, adding that the rupee, which has been resilient and stable, should be allowed to find its level and the central bank is only striving to rein in excessive volatility in the exchange rate.

“We must deal with the current global hurricane with confidence and endurance,” he averred, stressing that though India is decoupled from the global economy in several aspects, it cannot be entirely decoupled in an inter-connected world. “Our actions will be nimble and in the best interest of the economy. The aspect of growth will obviously be kept in mind,” the Governor underlined.

Wednesday’s rate increase was largely in sync with market expectations, and SBI group chief economic adviser Soumya Kanti Ghosh said there is a low probability of a “terminal 25 bps rate hike” at the next monetary policy review. “However, that (rate hike) if it were to happen, will also be accompanied with a change in stance to neutral,” he reckoned.

The next monetary policy review is due on February 8, soon after the Union Budget 2023-24 is presented and the U.S. Federal Open Market Committee policy statement in late January.