All boxes ticked

RBI is rightly focused on the inflation target

The Indian central bank’s monetary policy committee (MPC), as widely expected by financial market participants, left the policy repo rate unchanged at 6.5 per cent on Thursday. Consequently, the standing deposit facility and the marginal standing facility rate also remained unchanged. The MPC has increased the policy rate by 2.5 percentage points in the current cycle, which is still working through the system. The rate-setting committee did well to also leave the policy stance unchanged and will remain focused on the withdrawal of accommodation. There were expectations in certain sections of the market that the MPC would change its stance to neutral. However, such a change could have led to expectations that the MPC would reduce the policy rate in the coming months and go against the policy objective of the central bank.

Although the consumer price index-based inflation rate has come down, in the MPC’s assessment, it is still expected to remain, on average, above the 5 per cent mark this fiscal year. The committee justifiably did not lower the inflation projection significantly on the back of recent declines. The inflation rate in April came at 4.7 per cent. The MPC now expects an average inflation rate of 5.1 per cent in 2023-24, compared to the previous forecast of 5.2 per cent. This is sensible, given the kind of uncertainties that still persist in this context. For instance, while the monsoon is expected to be normal, there is concern over the El Nino effect, which could affect rainfall and farm output, with implications for inflation outcomes.

Nonetheless, given the overall inflation conditions, it appears that the policy rate has peaked. Any unexpected spike in the inflation rate on account of, say, food prices may be looked through by the central bank, particularly given the real policy rate of about 1.4 per cent over the projected inflation rate for the current year. However, households and businesses looking for a rate cut to contain interest outflows will have to wait. The projected inflation rate is still significantly above the target of 4 per cent. In this context, the message from the Reserve Bank of India (RBI) was categorical, as should be the case. As RBI Governor Shaktikanta Das rightly noted in his remarks: “...we need to move towards our primary target of 4 per cent inflation. It is always the last leg of the journey which is the toughest.” Thus, the RBI will need to hold the policy rate till it attains the target on a durable basis. It will also have to manage liquidity conditions deftly to avoid any premature easing of financial conditions.

In terms of gross domestic product growth, unlike some private-sector forecasters, the MPC has retained its projection at 6.5 per cent for the ongoing fiscal year, though the quarterly forecasts have been re-jigged. Although high-frequency indicators, such as the purchasing managers’ indices, appear encouraging, it remains to be seen how the year progresses. In fact, given global risks to growth, attaining 6.5 per cent real growth would be challenging. Further, the projection suggests a significant loss of momentum through the year — from 8 per cent in the first quarter to 5.7 per cent in the fourth quarter — which is concerning. However, in this context, policy intervention from the government would be more critical. The central bank would do well to remain focused on attaining the inflation target.