Uncertainty on inflation and growth means the RBI keeps its options open

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) raised the policy rate today by 35 basis points (bps) to 6.25%. The decision to slow the pace of rate hikes (compared with the previous three instances of 50 bps hikes) was largely expected, given that upside risks to inflation are moderating, and it is forecast to come within the RBI’s target range by next fiscal. Yet, as the governor mentioned, the battle against inflation is not over (core inflation being the biggest problem), and hence, a calibrated monetary policy action is the need of the hour. The MPC has so far raised rates by a cumulative 225 bps this fiscal.

The MPC maintained its stance on ‘withdrawal of accommodation’ as liquidity conditions remain in surplus and the policy rate adjusted for inflation remains negative. Interestingly, though, the accommodative stance was decided by a 4-2 majority (compared with 5-1 in the September meeting), reflecting the increasing divergence in views of MPC members.

Pressures on inflation are slowly shifting from the supply side to the demand side as food and fuel inflation moderates (owing to climb down in global commodity prices and arrival of kharif crop/winter vegetable harvest), but core inflation remains sticky (from recovering demand for services and pass-through of input costs to consumers). The MPC’s decision to slow its rate hikes was thus predicated on inflation moderating, which does not require the central bank to tighten monetary policy as much as earlier. But tightening continues as inflation remains elevated vis-à-vis its target, and uncertainty abounds. The US Federal Reserve (the Fed) is also considering a slower pace of rate hikes (albeit with a higher terminal rate than previously indicated), which could imply lower spill-over risks to the rupee and domestic financial conditions, and thus a lesser need to tighten.