RBI Likely To Opt For Status Quo On Rates

The Monetary Policy Committee meeting this week takes place in a diverging macro backdrop—globally, inflation has been slow to fall and while central banks in advanced economies seem to be converging on peak rates, the timing of a turn remains uncertain.

In contrast, India’s inflation has been trending down since February 2023, and is likely to be only moderately above the central bank’s medium-term target of 4% in the coming months. The economy also appears to be on a steady footing with GDP for the quarter ending March 2023 expanding 6.1% year-on-year, which was higher than consensus expectations and the 4.5% recorded in the previous quarter.

For India, we believe the hiking cycle ended in April when the MPC voted to hold rates steady. As such, we expect the MPC to also keep the repo rate unchanged in the June MPC. We think receding concerns over the persistence of inflation, high real rates and a need to evaluate the full impact of earlier rate hikes will likely drive the committee’s decision. The rise in headline inflation has also slowed in the past few months, which should ease concerns that supply shocks to inflation are permeating into the demand side.

Real interest rates, that is, the policy rate minus inflation rate, are also relatively high compared with the rest of emerging Asia and the advanced economies of the West. Lastly, the transmission of policy rate hikes announced in the past year is still ongoing; for instance, while the repo rate has been hiked by 250 bps in the current cycle, deposit rates have risen by just 125 bps while lending rates on new loans are up by 158 bps.

A potential issue for the RBI over the longer term is a likely stickiness in price levels, even though the inflation rate itself may be falling. The combination of solid GDP growth momentum and falling input costs amid declining international commodity prices is strengthening corporate pricing power. So, while a moderation in the inflation rate should allow the RBI room to hold, a general stickiness in prices means that a view may emerge that lowering of rates is not necessary. Additionally, with risks of El Nino impacting this year’s monsoon and, consequently, food inflation, we think the RBI will be wary of letting its inflation guard down. As such, we see the central bank opting for a prolonged pause in policy rates.

No change in repo rate, however, does not mean that the MPC meeting outcome will be uneventful—Its projections for inflation and growth will be closely watched. Inflation readings have undershot the RBI’s projections since the April meeting, which makes us think the central bank will likely reduce its forecasts for the current fiscal year closer to 5% from the current 5.2% average, with bulk of the forecast downgrades being made for Q1 and Q2 FY23-24. On growth, forecasts are likely to be left unchanged- we think the RBI is comfortable with its existing FY23-24 forecast of 6.5%, given the steady growth momentum continuing into the current quarter, albeit with some uncertainty from the slowing global growth backdrop.

We think some assurance around concerns over inflation persistence can be deduced from the slight softening in tone of the MPC members’ comments in the most recent meeting. The central bank’s internal research publications are also flagging a moderation in risks to inflation (RBI Annual report, FY22-23) and the fact that underlying price momentum is taking a leg lower.

In sum, we think a lower inflation trajectory, steady economic growth amid continued geopolitical uncertainty and external demand headwinds imply the RBI will prefer to watch from the sidelines this week.

Rahul Bajoria is a managing director and head of EM Asia (ex-China) Economics at Barclays, and Amruta Ghare is a regional economist.