The Reserve Bank of India’s (RBI) rate-setting panel, the Monetary Policy Committee (MPC), is unlikely to make a pivot on rate cuts in the current financial year as the focus remains on curbing inflation that has been above target for over three years now, according to Radhika Rao, Executive Director and Senior Economist, DBS Group Research.
The RBI’s inflation target is 4 percent with a tolerance band of two percentage points on either side. The current rate of inflation in the country is 6.44 percent.
Last week, the MPC surprised markets by leaving the repo rate unchanged at 6.5 percent while warning that its action should not be taken as a signal for forthcoming meetings as well. Despite this, markets and analysts have started eyeing a string of rate cuts, starting from as soon as October this year.
“The MPC surprised with a pause but emphasised that the path ahead will be nimble to address evolving inflationary risks and maintain its hawkish stance,” Rao told Moneycontrol in an interview.
‘Rate cuts not on the anvil’
“We are not in the camp looking for a quick pivot towards rate cuts in 2023. Given the band of uncertainty over inflation forecasts and the MPC’s positive views on growth, rate cuts are not on the anvil,” she said.
Reduction in rate cuts is likely only in 2024, likely in the early part of the next fiscal year, according to the senior economist.
RBI started raising interest rates in May 2022 to curb red-hot inflation. Since the start of 2022, inflation has been above the 6 percent threshold in all but two months, and has spent 41 months in a row above the central bank's medium-term target of 4 percent.
Monetary policy had been loosened significantly in India after the pandemic hit in early 2020, leading to one of the world’s most stringent lockdowns in the world’s second-most populous country.
The RBI’s actions since the pandemic were largely in line with what was happening across the world.
More recently, the banking crisis in the West has forced a rethink on how much central banks can tighten in the current cycle.
DBS is of the view that the US Federal Reserve is trying to “tread the balance between varnishing its inflation-fighting credentials while displaying the impact of the cumulative tightening in this cycle, along with the worsening financial conditions due to banking system-related issues,” according to Rao.
The brokerage house predicts a possible additional US tightening of 25 basis points with a caveat about data dependency.
What led the MPC to take a pause
In India, the forward-looking inflation path and a cautious view on global financial stability risks might have led the MPC to apply the brakes on the rate hiking cycle this month.
Still, the MPC maintaining its ‘withdrawal of accommodation’ stance underscores the central bank’s hawkish bias, given the upside risks to the inflation trajectory, Rao said.
“This is also a signal to market participants that, if not rate hikes, the next path of least resistance is to be on an extended pause, rather than a quick pivot to lowering rates,” she added.
Inflation challenge
Upside surprises from a rally in oil prices or weather-related problems could upset the MPC’s inflation math, Rao said.
While any possible weather-related inflationary shocks are best addressed by fiscal measures rather than monetary policy action, it will be harder for the RBI against this backdrop of rising price pressures, she added.
“It will be hard to address inflation that is purely driven by supply shocks, requiring the monetary policy overtures to be accompanied by administrative and fiscal measures. Keeping inflation in control would also be desirable in the run-up to the general elections,” she said.
The RBI has emphasised that price stability is a priority and that the inflation target of 4 percent remains in view, even if that might be hard to achieve this year.
Growth impulse
DBS has a more conservative view on growth than the RBI’s 6.5 percent prediction for this fiscal due to challenging global conditions, tight financial conditions, and anticipated normalisation in demand.
“Normalisation in demand is likely as the pandemic reopening benefits dissipate, while financial conditions remain tight and global outlook becomes cloudy,” Rao said.
“These are factors that will hinder a sharp pick up in private sector capex, but we are confident that the strong capex as well as infra pipeline established by the public sector, especially central government, will be able to pick the slack of a slowdown.”