RBI: Better to be cautious than concerned

Even after some easing of inflation risks, the Reserve Bank of India's monetary policy committee (MPC) voted unanimously to increase the repo rate by 50 bps, taking the key policy rate to 5.40 per cent. The MPC took a calibrated and measured view, staying with its message of “withdrawal of accommodation,” and reiterating its commitment to bring inflation within target while supporting growth.

Viewed purely through a macroeconomic lens, the decision was perhaps unexciting since economic projections were left unchanged. Still, we sense that there is a large amount of caution built into the projections, especially on inflation. The Governor did emphasise that while inflation is showing signs that it may have peaked, the central bank believes a cautious approach is better, given that inflation could be accentuated by the strengthening of the dollar, and risks over the Kharif farm output, especially for paddy. The RBI kept its growth projections broadly intact, even as it underscored the increasing headwinds in terms of weakening global growth and higher input costs.

To us, the important emphasis was on external stability, which the RBI has clearly placed a lot of importance on. The RBI is looking at a number of challenges in the coming quarters - geopolitical uncertainty, its commitment to keep the current account deficit within sustainable limits, and maintaining adequate funding sources. A more stable rupee would help by reducing the pressure on the RBI to use monetary tools to limit volatility.

Overall, the MPC’s decision was more hawkish than we had expected, and suggests policy makers are being cautious, especially ahead of the winter cycle, when energy prices could be volatile.

To us, the risks are clearly biased towards inflation coming in below the RBI’s forecasts. We believe, over the next six months, that baseline inflation forecasts will be back within the CPI inflation target, which may imply a more moderate assessment of inflation risks at future MPC meetings.

Over the next two meetings (September and December), we expect that the Reserve Bank will continue to highlight inflation management as its key policy priority, until inflation returns within the target range. We expect the RBI to deliver a 25 bps hike at the September policy review and shift to a neutral policy stance.

Beyond that, we expect the RBI to deliver one more 25 bps rate hike in December, taking the repo rate to 5.90 per cent. However, if global commodity prices continue to decline, we note the risk that the bank does not raise rates in December. Given the moderation in inflation by December, the RBI will also have brought its ex-ante real rate to its target level, leaving limited scope for further rate increases.

The author is MD & chief India economist, Barclays. Views expressed are personal