RBI signals it’s now at cruising altitude
PremiumRapid economic and geopolitical changes continue to cloud inflation, growth outlooks
There was some speculation whether today’s MPC meeting would see governor Shaktikanta Das for the first time needing to break a tie on the direction of interest rates with his vote. However, what we saw was a convergence on concerns rather than a divergence on worries. The committee’s decision to pause, albeit with a warning that the decision was only for now, is indicative of where RBI and the committee members see the balance of risks.
‘Uncertainty’ seemed to be the key theme and was invoked four times by governor Das in his statement – and not without reason. India, along with other major EM economies, faces a multitude of uncertainties emanating from China’s rapid re-opening, banking sector issues in developed economies posing financial instability risks, and OPEC’s recent decision to cut crude oil output, among other developments. Rapid economic and geopolitical changes continue to cloud inflation and growth outlooks. There was thus a good reason for caution, as is also evident in the governor’s statement that the “global economy is now witnessing a renewed phase of turbulence…overall outlook thus remains dynamic and fast evolving".
Still, with the MPC choosing not to raise policy rates today, we believe the window for future rate hikes has closed, as both inflation, growth, and global risks turn more benign in coming months, despite latent challenges. Let’s look at these three variables closely.
First, inflation – the target variable for the MPC – is on a moderating trajectory as price pressures ease across food, fuel and core components. Food inflation is expected to ease from a likely robust rabi harvest, fuel inflation may slow further from base effects and lower energy prices year-on-year, and core inflation also may inch down below 6% as commodity prices fall further, input costs ease and base effects play out. Indeed, the latest PMI readings for manufacturing and services showed input price inflation eased considerably.
That said, there are risks to inflation from weather-related events and volatile crude oil prices. RBI thus revised its inflation forecasts for FY24 downwards slightly by 10 basis points to 5.2% but within its target range. Additionally, the central bank maintaining the monetary policy stance gives it more room to operate and tighten policy via another instrument, namely, liquidity absorption, if required.
Second, RBI likely now wants to wait and assess the impact of its cumulative 250bp of hikes on inflation and aggregate demand. The MPC revising its GDP growth forecast for FY24 upwards to 6.5% can be read as the central bank is comfortable with the current growth trajectory. However, as monetary transmission plays out further, some dampening effect on demand should be expected. Given that domestic demand is currently robust (as evident in various high-frequency indicators), the central bank likely wants to avoid excessive tightening and instead engineer a soft landing.
Third, the global growth outlook has improved since the start of 2023. Growth dynamics thus far in the year have been shaped by the strong rebound in China and lower energy prices in Europe. These have pulled Q1 global growth higher and should continue to support momentum in Q2. Furthermore, the events with regard to banks in March have brought the end of the Fed and ECB hiking cycles closer and at slightly lower rates than previously expected before, which should also ease the pressure on RBI to raise rates to maintain interest rate differential.
For these reasons, we also believe a rate cut is also not likely in the near term. RBI is likely to be wary of letting down its guard on inflation, given the current uncertain environment and the risks from inflation running hot for longer.
The Indian economy is on firmer ground in 2023: domestic demand remains steady, current account funding needs are falling, and fiscal demands are in check. As inflation trends lower, the MPC will also likely keep an eye on growth, given headwinds from a global slowdown. Today’s decision is set in an increasingly VUSCA world – Volatile, Uncertain, Stagflationary, Complex and Ambiguous – but domestic resilience and a continued focus on inflation should help to steer the economy out of these choppy waters.
Rahul Bajoria is managing director and head of EM Asia (ex-China) Economics and Amruta Ghare is regional economist at Barclays.
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