RBI on a hawkish pause; aims to achieve 4 percent inflation

RBI Governor Shaktikanta Das Image: Punit Paranjpe / AFP

India’s central bank followed the script. No surprises and no shocks either. As widely expected, it delivered a status quo credit policy. The six-member rate-setting panel unanimously voted to hold the benchmark repo rate at 6.5 percent and five members voted to continue with the policy stance and focus on withdrawal of accommodation. The Reserve Bank of India (RBI) marginally lowered its inflation forecast to 5.1 percent from 5.2 percent, but kept its growth estimate unchanged at 6.5 percent for FY24.

Although the RBI tweaked its inflation forecast by 0.1 percent for the current financial year, it is on the front foot. A closer look at the growth and inflation projections indicates that the RBI is cautious about the second half of FY24—when it expects growth to lose momentum and inflation to rise (see table). There are concerns around higher government spending in the run-up to elections and the impact of weather conditions on food prices. Clearly, despite the recent moderation in price levels, the war against inflation is far from over.

In fact, RBI Governor Shaktikanta Das reiterated, “Let me re-emphasise that headline inflation still remains above the target and being within the tolerance band is not enough. Our goal is to achieve the target of 4 percent, going forward.” This is an important policy cue for the rate trajectory in the coming months. “While risks to near-term inflation have moderated somewhat, pressure remains during the second half of the year which needs to be watched and addressed at an appropriate time,” he said.

Das highlighted the need to be hawk-eyed on the evolving inflation situation even though inflation expectations of households for three months to one-year-ahead horizon moderated by 60 to 70 basis points since September 2022, indicating that monetary policy actions are yielding the desired results. This explains why five out of six members voted to keep the policy stance unchanged.

“Close and continued vigil on the evolving inflation outlook is absolutely necessary, especially as the monsoon outlook and the impact of El Nino remain uncertain. Taking all of these factors into account, the Monetary Policy Committee decided to remain focussed on withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth,” Das added.

The central bank noted that urban spending remains robust and rural demand is improving, though unevenly. Das pointed out that fiscal consolidation is ongoing and domestic macroeconomic fundamentals are strengthening: Economic activity is exhibiting resilience; inflation has moderated; the current account deficit has narrowed; and foreign exchange reserves are comfortable.

Also read: India's Goldilocks economy: Will the RBI change its policy stance?

But Das agreed that global headwinds persist. “Unlike the previous three tumultuous years, the uncertainty on the horizon appears comparatively less and the path ahead somewhat clearer; but we have to be acutely aware that the geopolitical conflict continues unabated and policy normalisation globally is far from complete. Headline inflation across countries is on a downward trajectory, but is still high and above the targets,” he stated.

Markets were largely unaffected by the tone of the policy. The ten-year bond yield inched up by 0.46 percent to 7.01 percent and the S&P BSE Sensex was flattish. Aurodeep Nandi, India Economist and vice president at Nomura called it a ‘Goldilocks’ pause for the RBI.

“In the run-up to the policy meeting, the economy finds itself in a fortuitous ‘Goldilocks’ macro situation, with better-than-expected Q4FY23 GDP growth and inflation tracking closer to the RBI’s midpoint target of 4 percent. Hence, the macro conditions remained conducive for the RBI to pause and reinforce its FY24 forecasts for GDP growth at 6.5 percent and a slightly lowered CPI inflation at 5.1 percent. Governor Das remained bullish on growth and hawkish on inflation, reiterating the RBI’s inflation target of 4 percent. Our macro view though remains that both growth and inflation are likely to undershoot the RBI’s projections in FY24,” he says.

Also read: Monsoon pivotal for government to manage inflation & growth in pre-election year
 
Sampath Reddy, chief investment officer, Bajaj Allianz Life Insurance believes that we are close to the end of the rate hike cycle. “The RBI governor has highlighted potential downside risks to the economic outlook, including weak external demand, geo-economic fragmentation, and prolonged geopolitical tensions. Despite these risks, the RBI has maintained India's GDP forecast for FY24 at 6.5 percent due to the resilience of the country's economic activity. The RBI governor also indicated that the demand conditions will remain supportive of growth leading to favourable conditions for pick-up in capex in Indian economy. Following the policy announcement, bond yields remained largely unchanged as the markets had already factored in the anticipated decision,” he says.  
 
Lakshmi Iyer, CEO-investment and strategy, Kotak Investment Advisors, says the policy decision to remain status quo was in line with street expectations. “Given that global macro headwinds are still visible, the members did not feel it appropriate to change their stance. It looks like the market wait for rate cuts just got longer, as we saw Canada policy makers announce a surprise rate hike. Key incoming data dependency will continue to be the order of the day. Policymaker guard rails remain. Bonds may continue their sideways movement and continue to track global bond yields, specifically US treasuries,” she adds.