Monetary and fiscal policies in India continue to be largely growth focused. At the same time, there is an attempt to slowly dial back the exceptionally supportive stance taken to contain the pandemic-induced damage to the economy. To support growth, Union Budget 2022-23 delayed the fiscal consolidation path and reshuffled pandemic-related spends in favor of investments. By fiscal 2026, the deficit is expected to narrow to 4.5% of gross domestic product (GDP), still higher than the pre-pandemic level of 3.3%. This provides fiscal space to address spending needs, while not losing sight of the imperative to pare debt and deficit. India, after all, has the highest debt ratio among similarly rated countries. The budget also pared the subsidy bill by almost 26% to move it towards prepandemic levels.

Higher deficit target for the coming fiscal inflated the central government's borrowings to Rs 14.95 lakh crore for fiscal 2023 from Rs 10.9 lakh crore in the previous fiscal. This surprised the markets and immediately spiked government bond yields, which were already under pressure from high crude prices, inflation and the United States Federal Reserve's (US Fed) abrupt change in its monetary policy stance. In a similar vein, the Reserve Bank of India (RBI) left interest rates unchanged in its February monetary policy. The central bank's dovish stance calmed the nervous bond markets and bond yields stabilized closer to the pre-budget levels. Within the framework of its unchanged stance, the RBI did accelerate the process of normalizing liquidity in a calibrated manner via adynamic liquidity management approach and by restoring the liquidity management framework of February 2020. The RBI's stance is consistent with its benign projection of Consumer Price Index (CPI)-based inflation to average 4.5% in fiscal 2023. This is lower than street expectations of ~5% and CRISIL's forecast of 5.2% for the coming fiscal.

On a positive note, no one was expecting inflation to stray above 6% – the upper end of the tolerance band – in the coming fiscal. That said, this will be the third year of inflation staying above 4% (midpoint of 2-6%) – a level the RBI is targeting over the medium term. The RBI has so far remained tolerant to this slippage, as the economy needed support.

However, the situation is gradually changing as the risks are shifting from pandemic related to geopolitical developments/crude prices and the Fed's stance. This could have nudged the RBI to formally announce the process of normalization by raising the reverse repo rate, but it chose not to do so as it expects inflation to dip. If inflation plays out as the RBI has projected, we are in for a very gradual normalization pace and rate hikes will be delayed. But, if does not, the risk of a surprise hike in interest rates cannot be ruled out. Inflation outcome will be largely shaped by how geopolitical events and the impact on crude prices play out along with the strength and broad-basing of the domestic recovery.