The Reserve Bank of India’s rate rise later this week will be the last one of this cycle and the central bank will start preparing the ground for monetary easing later this year, according to economists.
The rate-setting monetary policy committee (MPC) holds its first meeting of the financial year 2023-24 from April 3-6.
“With the turmoil in the global banking system appearing to have eased and inflation still above the RBI’s 2-6 percent target range, we think the MPC will push ahead with a final 25bp hike to the repo rate (to 6.75 percent) at the conclusion of its meeting on Thursday 6th April,” Shilan Shah, Deputy Chief Emerging Markets Economist, Capital Economics, said.
“But growth is set to remain relatively soft and inflation is likely to fall back within target before long. Under those circumstances, we think the RBI could lay the groundwork for cuts before the end of the year and start delivering them in early 2024, a view that the consensus has come around to.”
The MPC slowed the pace of monetary tightening at its latest meeting in February with a 25 basis point hike to the repo rate, the rate at which the RBI lends funds to. The repo rate is now at 6.50 percent against the pandemic-era record low 4 percent.
The RBI, which failed to meet its inflation target last year, has raised rates sharply since May 2022 as it sought to curb red-hot inflation.
The headline consumer price inflation rose back above the 2-6 percent target range in January and, though it eased a touch in February, it remained elevated. This is likely to result in another rate hike this week.
“We expect the Reserve Bank of India to hike rates a further 25bp at its April meeting, taking the repo rate to 6.75 percent as inflation remains above the top of the upper target band (6 percent) and core rates of inflation also remain elevated.
“We do, however, think that this might be the last hike in this cycle as we expect inflation to drop sharply in March,” Robert Carnell, Regional Head of Research, Asia-Pacific at ING said.
Loosening of policy to begin later this year
Beyond the April meeting, economists expect the tightening cycle to come to an end as headline retail inflation will fall back within target by April-June and then remain there for the foreseeable future.
“Over the past 30 years, the gap between the final rate hike in the cycle and the subsequent first rate cut in India has been around four months, about average for EMs,” Shilan Shah said. “We don’t think the turnaround will be as quick this time round but, as growth cools and inflation settles at more comfortable rates, we think the MPC will be laying the foundations for loosening policy later this year, and start cutting rates in early 2024.”
The rate cuts next year will be deeper than expected, the economist added.
Some economists even expect a pause at this week’s meeting.
With the Silicon Valley Bank blow-up leading to a dramatic shift in expectations of how the US Federal Reserve will choose to fight inflation, chairman Powell has hinted at an earlier pivot compared to an extremely hawkish pre-SVB stance.
Hence, the RBI, too, may have to change its approach on monetary policy action, said Kunal Kundu, India Economist at Societe Generale.
While both headline and core inflation remain elevated, the RBI’s immediate focus would be to ensure that the strength and vitality of the banking system is not been compromised as it tries to cope with the impact of monetary policy tightening.
“Hence, after having delivered the fastest repo hike pace in more than two decades, we believe it would make sense for the RBI to pause and take stock of the situation,” Kundu said. “This would allow the lagged effect of transmission of the monetary policy action to play through before deciding on the next rate action. Hence, we expect the central bank to keep the policy rate unchanged at 6.5 percent at its meeting.”