This turnaround ain’t no pivot

The pause in interest rate hikes by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has occurred at a seemingly inopportune moment. Inflation is outside the RBI’s tolerance band, the real repo rate is below its pre-pandemic peak, liquidity is in surplus and the monetary stance remains accommodative. This unanimous decision is a turnaround from the MPC‘s last review meeting in February, when hawks in the committee prevailed over doves in voting 4:2 for a rate hike. Yet, the inflation scenario has changed since then, with the RBI lowering its projection for 2023-24, incorporating a steep decline in the last quarter, and on an assessment that inflationary expectations have declined. Stress in banking systems abroad has also tempered central bankers’ zeal to push for bigger interest rate increases. The Opec+ decision to cut production could establish a floor for crude oil prices that the RBI is comfortable with.

A pause at this juncture allows for recalibration of monetary policy after a fairly brisk 2.5-percentage-point increase in policy interest rates that have been transmitted, equally briskly in the RBI’s view, to the financial markets. The credit market in India is being tightened in an orderly manner with little evidence of stress in the banking channel due to the central bank’s liquidity drawdown. Credit growth is robust and second-order effects of costlier credit are yet to be established as they filter through the real economy. High-frequency indicators for the last quarter of 2022-23 point to a pick-up in both rural and urban demand. The RBI’s latest projection for GDP growth in 2023-24 is slightly more optimistic than two months ago.

RBI governor Shaktikanta Das took pains to establish the MPC decision was a pause and not a pivot, keeping the door open for further rate hikes down the line if inflation remained stubborn. That may not be necessary, though. Last year’s high base effect will come to the aid of the MPC in pulling the headline inflation rate into its target band.