Staying the course: What could prompt the RBI to change its approach?

Even though the Reserve Bank of India (RBI) has consistently sounded hawkish since April 2022, what made this MPC decision different was that it was the first time in six meetings that the central bank materially raised its inflation projections. This action summed up the policy bias, which remains focused on bringing inflation close to the target level of 4 per cent. The only silver lining is that the current price rises are being driven by supply-led shocks, which are outside of the RBI’s ambit. However, there are some concerns creeping in about the interest rate trajectory if inflation stays higher for longer.

Governor Das’s comments rightly struck a cautious note on inflation: While he highlighted that vegetable prices are likely to reverse “quickly”, he expressed some concern that recurring food shocks could possibly affect inflation expectations. So even though monetary policy cannot directly counter supply-led shocks to food prices, authorities can still demonstrate their commitment to controlling inflation to avoid inflation expectations becoming entrenched (which can also have further knock-on effects on actual inflation). For now, the central bank has decided to look through the current spike in perishable food prices. Still, it was not a “sound hawkish, but do-nothing for now” policy announcement: The RBI indeed chose to act on existing surplus systemic liquidity by raising the incremental cash reserve ratio (on a temporary basis) to facilitate the transmission of earlier rate hikes.

The RBI has now maintained rates and its stance for three consecutive meetings, indicating a broad comfort with policy settings. In our view, the current bout of price spikes, albeit driven by temporary factors, validates the RBI’s caution and further underpins the idea of an MPC on an extended pause and not one preparing to pivot. While inflation is expected to remain within the target range of 2-6 per cent on average this fiscal year, Governor Das has repeatedly highlighted the need to bring it towards the medium-term target of 4 per cent. Again, this confirms our view of the RBI being on a “hold for longer” outlook.

In an environment of global rates also likely remaining higher for longer, we think the window for rate cuts by the RBI will open only in the financial year ending March 31, 2025 (FY25).
 

What could prompt the RBI to change its approach?

We think it would take either a slowdown in domestic growth, or negative spillovers from a sharply slowing global growth to push the central bank into a policy pivot. Both these scenarios are unlikely in our view, given the current momentum in domestic activity, and while global growth is moderating, it is not collapsing. This should allow the RBI to avoid easing policy prematurely, especially given the uncertainties over international energy and food prices, geopolitics, and El Niño. The RBI’s comfort with current growth momentum was apparent in it maintaining its GDP growth forecast at 6.5 per cent. Barring the recent transient price shocks, India’s underlying inflation is on a moderating trajectory, even as most central banks globally continue to face the growth-inflation trade-off. We think RBI’s objective now is to preserve India’s hard-won macro stability, while keeping economic growth rate reasonably elevated.

Rahul Bajoria is managing director and head of Emerging Markets Asia (ex-China) Economics at Barclays, and Amruta Ghare is regional economist