RBI keeps rate on hold, talks tough on inflation

The Reserve Bank of India expectedly kept the policy rate unchanged, even as its hawkish tone on inflation, and, by extension, interest rates, is likely to have brought little cheer to corporate and retail borrowers, especially the latter, who have seen mortgage payments balloon.

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“The ideal (CPI inflation at 4%) must not be lowered”, is the message Governor Shaktikanta Das conveyed after the conclusion of the bimonthly Monetary Policy Committee (MPC) meeting of RBI on June 8. To be sure, MPC’s key decisions of keeping the policy rate unchanged at 6.5%, and maintaining monetary policy stance as withdrawal of accommodation were widely expected. However, the tone of the latest MPC resolution has made it clear that the central bank continues to sees the fight against inflation as a work in progress, which, it believes, could face disruption from a sub-par or geographically skewed monsoon and inflation expectations getting entrenched at higher levels. And given the upbeat commentary the MPC resolution has about the state of the Indian economy, it is likely that the recently released higher-than-expected GDP growth numbers have convinced RBI to go harder on inflation without worrying about the collateral damage to growth.

Meeting in the aftermath of a better-than-expected GDP growth – it came at 6.1% against a Bloomberg forecast of 5.1% -- in the quarter ending March 2023, and benchmark inflation, as measured by the Consumer Price Index (CPI), falling to an 18-month low of 4.7% in April, MPC’s decision and commentary betrays a slightly hawkish attitude.

While the unanimous decision to keep the policy rate unchanged at 6.5% was widely accepted, withdrawal of accommodation being retained as the monetary policy stance saw a dissension within MPC. The MPC resolution has kept its April meeting’s projection for annual GDP growth in 2023-24 unchanged at 6.5%. The retail inflation forecast has been lowered by ten basis points – one basis point is one hundredth of a percentage point – to 5.1%. Quarterly projections (beginning June 2023) are 8%, 6.5%, 6% and 5.7% for GDP growth and 4.6%, 5.2%, 5.4% and 5.2% for retail inflation. The MPC commentary, when read with the latter set of numbers, explains why inflation continues to worry RBI.

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“Going forward, the headline inflation trajectory is likely to be shaped by food price dynamics”, the MPC resolution said on a day when the India Metrological Department announced the onset of the south-western monsoon, which independent experts believe could perform below-par this year in terms of rainfall. “The forecast of a normal south-west monsoon by the India Meteorological Department (IMD) augurs well for kharif crops; however, the spatial and temporal distribution of the monsoon would need to be closely monitored to assess the prospects for agricultural production”, MPC resolution’s take on the monsoon sought a middle ground between the official and independent prognosis about the monsoon. While IMD has forecast a normal monsoon, its projection of rainfall that is 96% of the long period average, is at the lower end of the normal band; At 95% it would have been below normal.

Experts agree with MPC’s assessment. “We believe that with unchanged rates and stance, RBI remains rightfully cautious at a time El Nino could impact monsoon rains, and global inflation and growth conditions remain uncertain”, said a note by Pranjul Bhandari, Chief India and Indonesia Economist, HSBC, referring to the weather phenonomenon that causes the warming of the equatorial Pacific Ocean and is correlated with poor monsoons. “ RBI seems rather cautious on its inflation forecast for the near term. For instance, it forecasts June inflation at 4.7%, while we believe inflation could come in lower at around 4.3%”, the note added.

To be sure, not all of the hawkishness on part of the RBI is on account of rainfall worries. “Early results from the Reserve Bank’s surveys, manufacturing, services and infrastructure firms polled expect input costs and output prices to harden”, the MPC resolution noted, underlining a worry that inflation expectations need to be brought down by showing unequivocal policy intent to live up to the inflation targeting task MPC has been mandated with. It is this piece of evidence which might have triggered the hard-talk, especially by Governor Das, around the centrality of the 4% inflation target for RBI. It is noteworthy that India’s recent brush with high inflation saw headline CPI staying above 6% for five consecutive quarters ending March 2023 even as t core inflation – the non-food non-fuel part of the CPI basket – was above 6% for eight consecutive quarters ending March 2023.

Unlike its risk-averse posturing on inflation, RBI’s tone on the economy’s growth prospects was more relaxed. “Domestic demand conditions remain supportive of growth on the back of improving household consumption and investment activity”, Das said in his statement, even as he highlighted the “headwinds from weak external demand, volatility in global financial markets, protracted geopolitical tensions and intensity of El Nino impact”.

To be sure, MPC also hinted that its past rate hikes – policy rates have increased by 2.5 percentage points between May 2022 and February 2023 – will put some downward pressure on domestic growth. “The cumulative rate hike of 250 basis points undertaken by MPC is transmitting through the economy and its fuller impact should keep inflationary pressures contained in the coming months”, the MPC resolution says. Inflation targeting’s theoretical framework is premised on the fact that interest rate hikes can control inflation by generating a demand shock due to higher cost of (credit-funded) investment.

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“After a cumulative hike of 250 basis points (2.5 percentage points) last fiscal, the central bank has moved to the sidelines to see their impact on growth and inflation play out this fiscal”, Dharmakirti Joshi, Chief Economist, CRISIL, said in a note, while adding that a weak private consumption demand “is likely to moderate demand conditions in the current fiscal given that bank lending rates are now higher than pre-pandemic five-year average”.