Expect 25-bp hike before RBI presses pause button

The rate-increase cycle, which started in May 2022, raising the policy rate from 4 to 6.25 per cent to fight entrenched inflation, is nearing its end

Later this week, the Reserve Bank of India (RBI) will take a call on policy rate at the end of its rate-setting body, the Monetary Policy Committee’s, last meeting of FY23. The backdrop of the policy is the Union Budget and rate actions of four global central banks in the past fortnight.

The Bank of Canada raised its benchmark interest rate, yet again, to 4.5 per cent. This is in line with expectations since it has been fighting hard with record high inflation. This is the eighth hike in less than a year but the smallest since March and signals that the Bank of Canada may be done with hiking rates for now.

The US Federal Reserve, too, delivered a slower pace of rate hike — 25 basis points (bps) — taking it to 4.50-4.75 per cent. One bps is a hundredth of a percentage point. In the current cycle, the Fed has raised the rate by 450 bps so far. Here, too, the hike is in sync with market expectations as inflation has slowed and the impact of the monetary tightening cycle has not been fully felt in the economy.

While the pace of rate hike slowed, the guidance of continued rate hikes was given both in the policy statement as well as in the press conference. Future actions will be “data-dependent” — the Fed would fine-tune the degree of tightening, based on the evolution of data. Meanwhile, the strong non-farm payroll number has complicated things and the US 10-year bond yield jumped to 3.53 per cent from 3.39 per cent.

The Bank of England (BoE) has signalled that the tide was turning in its battle against high inflation after it hiked the policy rate for the tenth time in a row. On a 7-2 vote by the BoE’s rate-setters, the bank rate has risen by 50 bps to 4 per cent — its highest since 2008.

“We’ve seen the first signs that inflation has turned the corner,” BoE Governor Andrew Bailey has said. “But it’s too soon to declare victory just yet; inflationary pressures are still there.” Going forward, the rate hikes would depend on how the inflation behaves.

Finally, the European Central Bank (ECB) has raised interest rates by 50 bps and explicitly signalled at least one more 50-bps hike next month, staying on course in its fight against high inflation. Analysts see the rate-hike cycle nearing the end, but ECB President Christine Lagarde has a different take.

“No. We know that we have ground to cover, we know that we are not done,” she has said, reiterating the ECB’s determination to “stay the course” in the fight to bring inflation down.

In sum, while the ECB maintains its hawkish guidance, the action of both the US Fed and the BoE will be data-dependent, and the Bank of Canada seems to be ready to press the pause button for the time being.

What do we expect from the RBI?

The Budget has stuck to fiscal consolidation. And, the central bank is expected to stick to its task of anchoring inflation.

After breaching the upper end of the flexible inflation target (4 per cent plus/minus 2 per cent) for 10 months in a row (the highest was 7.79 per cent in April 2022), CPI inflation dropped to 5.88 in November and 5.77 in December. Analysts expect it to be around 6 per cent in January and February but by March it may come down to 5 per cent, or even less, as the base effect starts kicking in before rising again marginally from the second quarter of FY24.

In the December policy, the RBI had projected CPI inflation at 6.7 per cent in FY23 — 6.6 per cent in the third quarter and 5.9 per cent in the fourth, which ends in March. Its projection for the first quarter of FY24 was 5 per cent and second quarter 5.4 per cent, on the assumption of a normal monsoon.

Should the RBI press the pause button now? A few analysts are rooting for it. Incidentally, in the December meeting of the Monetary Policy Committee, which raised the repo rate by 35 basis points to 6.25 per cent and retained its stance of “withdrawal of accommodation”, one committee member, J R Varma, voted against the rate hike and he, along with Ashima Goyal, another member, also disagreed with the stance of the committee.

My take is the rate-increase cycle in India, which started in May 2022, raising the policy rate from 4 per cent to 6.25 per cent to fight entrenched inflation, is not over as yet. We can celebrate the fact that inflation is coming down below 6 per cent and India has the lowest inflation among major economies, but it’s still far from the goal post — 4 per cent.

RBI Governor Shaktikanta Das is aware of this. After releasing the December policy, he had said: “On balance, the MPC was of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and contain second-round effects. These actions will strengthen the medium-term growth prospects of the Indian economy.”

He had also said, “GDP growth in India remains resilient and inflation is expected to moderate; but the battle against inflation is not over. Pressure points from high and sticky core inflation and exposure of food inflation to international factors and weather-related events do remain. While being watchful of the impact of our earlier monetary policy actions, we will keep Arjuna’s eye on the evolving inflation dynamics and be ready to act as may be necessary….”

The sore point is core inflation, which is not showing any signs of decline.

The December policy made it clear that the future course of action would duly consider new data releases and the evolving outlook of the economy as well as the effect of past actions.

More recently, delivering the keynote address at the annual conference of the Fixed Income Money Market and Derivatives Association of India and Primary Dealers’ Association of India in Dubai, Das hammered on the fact that globally central bankers had been looking for durable signs of lower inflation and while both inflation and growth outlook had improved, it’s better to keep all options open.

In the last policy, the RBI projected the real GDP growth for FY23 at 6.8 per cent, lower than what the finance minister has estimated in the Budget. Its projection for the first quarter of FY24 is 7.1 per cent and for the second quarter 5.9 per cent.

The Economic Survey has projected a GDP growth rate in the range of 6 to 6.8 per cent for FY24 even as the Budget projected a nominal GDP growth at 10.5 per cent.

In the evolving growth-inflation dynamics, I think the RBI should go for a 25-bps hike, its last, for the time being, taking the policy rate to 6.5 per cent. More than the rate action, markets will keenly watch the stance of the policy. Will it continue to be withdrawal of accommodation or, more nuanced, to give the feeling that India is heading towards the close of the rate-hike cycle?

The writer is an author and senior adviser to Jana Small Finance Bank Ltd

His latest book is Roller Coaster: An Affair with Banking

To read his previous columns, visit https://bankerstrust.in

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