The Reserve Bank of India's monetary policy committee (MPC) on Thursday sprang a surprise by unanimously deciding to keep the repo rate on hold at 6.50 per cent. Most economists had expected that the MPC would raise the benchmark rate at which the RBI lends commercial banks by another 25 basis points (0.25 per cent) and then pause in the subsequent meetings.
The expectation of a rate hike hinged on the fact that retail inflation had remained above the RBI's upper end of the 2 per cent to 6 per cent target. Furthermore, the European Central Bank (ECB) as well as the US Federal Reserve had continued to raise interest rates in their recent meetings.
So, what made the RBI MPC decide to keep the repo rate on hold? RBI Governor Shaktikanta Das flagged heightened volatility in global financial markets and downside risks from financial stability concerns, among the concerns.
"The global economy is now witnessing a renewed phase of turbulence with fresh headwinds from the banking sector turmoil in some advanced economies. Bank failures and contagion risk have brought financial stability issues to the forefront," said Das.
Amid the rapid rise in interest rates globally, three regional US banks collapsed in March. Across the Atlantic, Swiss banking giant Credit Suisse was hastily sold to larger rival UBS as regulators rushed to avoid the crisis from spreading and in turn calm financial markets.
Das stressed that the banking and non-banking financial service sectors in India remained healthy and financial markets had evolved in an orderly manner. He also pointed that in the past 11 months, the repo rate had already been raised by 250 bps. Taking into consideration the Standing Deposit Facility (SDF) at a rate 40 bps higher than the fixed rate reverse repo, the effective rate hike since April last year has been 290 bps, he added.
It was necessary to evaluate the cumulative impact of these rate hikes and under the circumstances, one had to be "extremely prudent" in the actions, he said.
"We have always been very watchful and have adopted a calibrated and balanced approach and will continue to do so."
However, he also stressed that the fight against inflation was far from over and Thursday's decision was a "pause" and not a "pivot." And he is right. After briefly slipping below 6 per cent in November and December 2022, inflation has once again risen. Retail inflation was at 6.52 per cent in January and 6.44 per cent in February. Core inflation has anyways been sticky around 6 per cent for some time now. Prices of cereals and milk have been on the rise and recent unseasonal rainfall in many states will add in to the pressure on agricultural produce.
The recent announcement of an output cut by OPEC and the resultant rise in crude oil prices could also put additional pressure.
"Our job is not yet finished and the war against inflation has to continue until we see a durable decline in inflation closer to the target. We stand ready to act appropriately and in time. We are confident that we are on the right track to bring down inflation to the target rate over the medium term," said Das.
The central bank expects retail inflation to moderate to 5.2 per cent in the year ending March 2024. CPI is projected at 5.1 per cent in the April-June quarter, 5.4 per cent in July-September as well as October-December and 5.2 per cent in the January-March 2024 quarter.
On the growth front, RBI sees GDP growing 6.5 per cent in 2023-24, up slightly from the 6.4 per cent it had forecast in the previous MPC meeting. The first quarter GDP is now seen at 7.8 per cent, second quarter GDP at 6.2 per cent, 6.1 per cent in the third quarter and 5.9 per cent in the fourth quarter.
RBI's optimistic forecast on growth is in contrast to recent downgrades by multilateral institutions like World Bank, which revised its India GDP growth forecast to 6.3 per cent from 6.6 per cent.
"The higher rabi production has brightened the prospects for agriculture sector and rural demand. The steady growth in contact-intensive services should be positive for urban demand. The government’s focus on capital expenditure, capacity utilisation above long-period average and moderating commodity prices should bolster manufacturing and investment activity," said Das.
However, he did note that protracted geopolitical tensions and global financial market volatility pose downside risks to the growth outlook.
As the the repo rate rose through 2022 and early 2023, interest rates on loans and mortages too have risen. With the central bank hitting a pause this time around, home loan borrowers may heave a sigh of a relief. However, if inflation continues to remain high, the RBI could yet again have to resort to further monetary tightening.
"We remain vigilant and ready to face the challenges with a firm commitment to price and financial stability," said Das.