As one would expect, the Reserve Bank of India (RBI) is widely seen delivering one final interest rate hike on April 6. The central bank's Monetary Policy Committee (MPC), which began its three-day meeting on April 3, is expected to increase the repo rate by 25 basis points to take the repo rate to 6.75 percent.
One basis point is one-hundredth of a percentage point.
It does not take much to come up with reasons to back the market view that the MPC will, later this week, raise the repo rate for the seventh time in less than a year. Headline retail inflation, after all, has rebounded to 6 percent-plus levels again and may exceed the RBI's forecast of 5.7 percent for January-March by as much as 50 basis points.
Further, core inflation – which the MPC has for the last few meetings cited as a key factor – has barely moved in the last half a year and remains above 6 percent.
Of course, monetary policy is not backward looking. And even the most forward-looking forecast of the RBI has Consumer Price Index (CPI) inflation at 5.6 percent in January-March 2024 – well above the medium-term target of 4 percent.
But if a convincing case can be made for the MPC to hike rates again this week, it is also possible to construct one with the opposing view.
Minority view
To be sure, it is not outrageous to think the MPC could choose to leave the repo rate unchanged at 6.5 percent on April 6. Back in February, two of the committee's six members had voted against the decision to increase the repo rate by 25 basis points. One can expect them to vote similarly this week.
But will anyone else join Ashima Goyal and Jayanth Varma? Their fellow external member, Shashanka Bhide, has so far kept his cards close to his chest and provided precious little in terms of his future course of action.
"At this point, we need to see a clear path to get closer to the target on the inflation front in the medium term," Bhide told Moneycontrol in an interview following the release of the February 6-8 minutes.
The RBI's representatives on the committee have been more vocal when it comes to focusing on inflation, with Deputy Governor Michael Patra making this telling comment in the minutes of the last meeting: "On a pragmatic basis, it is important to at least contain inflation within the tolerance band in 2023-24 as the first milestone to be passed in aligning inflation with the target."
Inflation call
Going by the RBI's own inflation forecast, inflation will be contained within the 2-6 percent tolerance band in 2023-24. What matters is whether the central bank has already done enough in terms of monetary tightening to bring inflation down in the coming months.
Soumya Kanti Ghosh, State Bank of India's group chief economic adviser, constructed four different scenarios using Artificial Neural Network models of machine learning and found the peak repo rate in the current cycle in the range of 5.2-6.3 percent.
"Thus in all the scenarios, the peak rate is lower than the current RBI rate at 6.5 percent. Alternatively, while RBI has managed inflation by frontloading the rate hikes, an appropriate policy response could be now looking through the cycle to gauge the impact of past rate hikes and take a considerate pause in April policy," Ghosh argued in a note on March 27.
It is worth noting that a terminal repo rate of 6.5 percent had been predicted by a current member of the MPC last year itself.
In August 2022, Jayanth Varma said the MPC's decision to remain focused on the withdrawal of accommodation could only refer to the withdrawal of pre-pandemic accommodation that began with the repo rate being cut from 6.5 percent to 6.25 percent in February 2019.
"A plain reading of this resolution would then be that the MPC is focused on taking the repo rate back to 6.5 percent. In my view, such an indication of a terminal repo rate of 6.5 percent is totally unwarranted in the situation that we are in," Varma had written in the minutes of the August 3-5, 2022 meeting.
Financial sector considerations
Whether the MPC has done enough to destroy demand and bring down inflation is anybody's guess. But inflation is not its only objective. Growth may be secondary in the order of things, but it cannot be ignored. The good, or surprising, news, is that RBI staff are bullish about the Indian economy "whatever the odds".
A third consideration of monetary policy, if not explicitly stated by law, is financial stability.
"While we are sympathetic to the view that a rate hike could be needed to nudge real policy rates firmly into neutral territory, we think risk-management considerations call for a pause in rate hikes," wrote A Prasanna, head of research at ICICI Securities Primary Dealership, late last month.
"Should the developments in the US worsen simultaneously with a rate hike by the MPC then the RBI and MPC will not be able to reverse course quickly and financial conditions could tighten far more than intended," Prasanna added.
Financial sector considerations are already having an impact on monetary policy. The Reserve Bank of Australia this week left its cash rate unchanged at 3.6 percent, saying that the recent banking system problems in the US and Switzerland have resulted in a "reassessment of the outlook for global interest rates".
"These problems are also expected to lead to tighter financial conditions, which would be an additional headwind for the global economy," the Australian central bank said on April 4.
All in all, the MPC can do whatever it wants and have enough reasons to back its decision, be it another hike or a pause.