Markets
Pause by RBI, served with caution
Summary
RBI has pointed out that real rates are positive and the banking system liquidity remains in surplus. Thus, through its rate decision, rhetoric and stance, the RBI has been able to remain committed to the inflation target.
New Delhi: The Reserve Bank of India (RBI) met market expectations at its June meeting. For the second time in a row, the central bank has kept the repo rate unchanged at 6.50%. This decision and unanimity among Monetary Policy Committee (MPC) members is hardly surprising amid recent easing in inflationary pressures and the resilience in India’s economic growth.
RBI has maintained its withdrawal of accommodation stance, with five MPC members voting in favour of it. It is of the view that headline inflation remains above target and being within tolerance band is not enough. Moreover, RBI has also pointed out that real rates are positive and the banking system liquidity remains in surplus. Thus, through its rate decision, rhetoric and stance, the RBI has been able to remain committed to the inflation target.
At the press conference, the RBI governor acknowledged the decline in domestic inflation, receding risks to its near-term trajectory and relatively lower global uncertainty. Plus, India’s domestic economic growth is on a firm footing. High-frequency growth indicators across manufacturing and service sectors such as purchasing managers index, core sector output and railway and domestic air passenger traffic have remained robust in the recent months.
Despite the gradual transmission of RBI’s 250 basis points of rate tightening taking effect, banking sector credit continues to post double-digit growth. In this backdrop, RBI has maintained its FY24 real GDP growth projection at 6.5%. Last week’s GDP data showed that FY23 growth stood at 7.2%, which was 40 basis points higher than the central bank’s projections.
Meanwhile, after an elevated course through 2022, price pressures have started easing, with headline consumer price index (CPI) inflation falling to an 18-month low of 4.7% y-o-y in April. More importantly, factors shaping CPI trajectory ahead seem relatively favourable. Projections of normal monsoon, positive outlook for kharif crops along with capped international commodity prices amid slowing global growth may keep volatile food and fuel inflation in check, though uncertainty on El Niño poses upside risks to inflation.
On the brighter side, stubbornly sticky core inflation (CPI excluding food and fuel) has finally started to soften amid some slowdown in aggregate demand and easing input cost pressures due to overall drop in commodity prices. This broad easing of price pressures has aided a sizeable decline in households’ inflation expectations since September 2022. Small wonder that RBI marginally lowered its FY23 CPI inflation projection to 5.1% y-o-y.
So, on one hand, the domestic economic growth is resilient and on the other, inflation is heading south. For now, it appears that there are fewer risks to the growth momentum and the inflation trajectory. With three consecutive months of decline in headline CPI, RBI’s relentless battle against inflation seems to be paying off. The same is acknowledged by the central bank governor, when he says, “Our monetary policy actions are yielding the desired results." Current favourable domestic growth-inflation mix suggests that a longer cycle of rate pause could be underway.
But it will be crucial to watch how RBI uses its policy tools in a world where other major central banks are yet to reach the end of monetary tightening. “We have to be acutely aware that the geopolitical conflict continues unabated and policy normalization globally is far from complete," Das said. RBI will likely have to calibrate and mitigate any spillover through capital flow and currency channels arising due to decoupling of monetary policy trajectories.
