An unexpected pause

Inflation remains significantly above the target

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), in its first meeting this fiscal year, surprised financial markets by unanimously deciding to leave the policy repo rate unchanged at 6.50 per cent. Most market participants, including eight out of 10 respondents polled by this newspaper, expected the rate-setting committee to increase the repo rate by another 25 basis points. But the MPC decided not to increase the policy rate further at this juncture, and assess how the cumulative rate increase so far works through the system. As RBI Governor Shaktikanta Das noted in his statement, the central bank has effectively raised policy interest rates by 290 basis points since April 2022 — accounting for the introduction of the standing deposit facility at 40 basis points above the fixed-rate reverse repo, which was the operating rate at that point.

Most of these facts, to be sure, were known to market participants, but they were still expecting the central bank to increase the policy rate, at least in the April meeting, largely because the retail inflation rate over the last two months had surprised on the upside and the fact that core inflation was also above the upper end of the tolerance band. Although the MPC has noted it “will continue to keep a strong vigil on the evolving inflation and growth outlook and will not hesitate to take further action as may be required in its future meetings”, the market would effectively take the present policy rate as the terminal rate for the current cycle.

Policy action and the accompanying statement thus raise several questions about the future course. For instance, the MPC decided to leave the policy rate unchanged after the inflation outcomes were above both its expectations and the upper end of the tolerance band. So what will it take for the MPC to act again? Further, would another rate increase of 25 basis points have been too restrictive in the given context? Notably, the MPC has increased the gross domestic product (GDP) growth projection for 2023-24 to 6.5 per cent from 6.4 per cent at a time when most other forecasters are lowering their projections. Professional forecasters polled by the RBI also expect GDP to grow 6 per cent this fiscal year. The MPC’s revised projections expect the inflation rate to moderate to 5.2 per cent in 2023-24. It can thus be argued that the RBI would maintain a real policy rate of 130 basis points in the current year, which may be good enough.

However, it is worth noting — as also rightly emphasised by the brass of the RBI in the post-policy press conference on Thursday — that the inflation target is 4 per cent. Thus, even in the current fiscal year, inflation outcomes would be significantly above the target. Since the RBI, along with several other central banks, has been underestimating inflationary pressures for quite some time, it is possible that actual inflation outcomes would still be closer to the upper end of the tolerance band. Therefore, given that core inflation has also been unyielding, it remains to be seen if a pause at this stage in what has been termed “the war against inflation” proves to be a wise decision. Households and financial markets would interpret it as the end of rate tightening.