Retaining policy flexibility

Inflation remains a concern for the RBI

The Monetary Policy Committee (MPC) ended its last meeting for this fiscal year on Wednesday with another 25-basis-point increase in the policy repo rate to 6.5 per cent. The standing deposit facility and marginal standing facility rates were accordingly adjusted to 6.25 and 6.75 per cent, respectively. While the rate action was on expected lines, the communication from the Reserve Bank of India (RBI) did not explicitly indicate that the committee will pause at the current level as many analysts were expecting. The biggest reason for this is that the central bank intends to keep its options open. It is still not comfortable with the level of inflation. The inflation rate based on the Consumer Price Index came below the upper end of the tolerance band in November and December, largely because of a sharp decline in vegetable prices. Core inflation continues to remain sticky and above the upper end of the tolerance band.

The MPC, nonetheless, expects the inflation rate to moderate in the coming fiscal year to 5.3 per cent, compared to 6.5 per cent in 2022-23. The rate is not expected to go below 5 per cent in any quarter next fiscal year, which means it will remain considerably above the inflation target of 4 per cent. The RBI’s inflation projection is slightly higher than what market analysts are expecting and is likely to be revised lower in the coming meetings of the MPC. Inflation is expected to moderate in most parts of the world in 2023, though the ongoing Ukraine war remains a significant risk for global commodity prices. In terms of growth, the RBI expects the Indian economy to expand 6.4 per cent in 2023-24, compared to 7 per cent this fiscal year as projected by the National Statistical Office. This again appears to be an overestimate. The central bank, for instance, anticipates the Indian economy to grow at 7.8 per cent in the first quarter of 2023-24. This looks fairly high, even as it expects growth to come down over the remaining quarters. It is thus likely that both the growth and inflation forecasts for 2023-24 would be revised lower in the coming quarters.

In terms of future rate action, although the MPC has kept its options open, it may want to pause for a while to see how the cumulative rate increases in the current cycle influence inflation outcomes. Notably, two members of the committee voted against a rate hike in this week’s meeting. Although the precise reasons for dissent will be known when the minutes of the meeting are released, it is likely that the MPC members would want to gauge the impact of rate hikes before increasing it further from the current level. It is worth noting that the real policy rate will be in positive territory over the next fiscal year. It will be thus crucial for the MPC to broadly determine the level of real policy rate that would be consistent with its objective of attaining the inflation target over the medium term. This, along with evolving inflation conditions, would influence future policy action. Besides, although the current account deficit is likely to come down, the RBI will need to remain vigilant on the external front. A significant movement in the currency will have implications for inflation outcomes.