RBI Monetary Policy: Prepping For A Pause

The RBI's Monetary Policy Committee is expected to continue its rate-hiking cycle, albeit at a slower pace, in December.

From the MPC's last resolution in September to the one scheduled for Wednesday (Dec. 7), the environment continued to cool, with inflation dropping to its lowest level in three months even as the Indian economy continued to show signs of resilience amid increasing global headwinds.

The MPC has raised the benchmark repo rate four times in a row to quell inflation. The rate now stands at 5.9%. A Bloomberg poll of 35 economists forecasts a 35-basis-point hike to 6.25% on Wednesday.

With the Fed indicating its desire to slow down the pace of rate hikes to 50 basis points and October U.S. CPI momentum easing relative to expectations, thereby reducing the depreciation pressure on the rupee, the MPC will be comfortable dialling down the pace of rate hikes to 35 basis points in December, according to a research note by Kaushik Das, chief economist at Deutsche Bank.

"While two non-RBI MPC members have favoured a pause at this stage, we think the MPC will still deliver a 35 basis point hike by a 4:2 majority in the upcoming monetary policy," Das said.

Madhavi Arora, lead economist at Emkay, also expects the MPC to ease its pace of hikes this week and deliver a 35-basis-point hike. "The decision could possibly get more divided in the form of a vote split, as is evident from the minutes of the [last] meeting," she said.

If the MPC opts for a 35-point hike, ex-ante real rates would exceed 135 basis points, well above the RBI’s indicated level of neutral rates, which is about 90 basis points, according to Barclays. "In our view, a shift to a neutral stance would send a strong signal that policymakers believe they have completed most of the rate increases," said Rahul Bajoria, chief economist at Barclays.

The CPI inflation eased to 6.77% in October after rising to a five-month high in September, led by a favourable base effect.

The headline inflation, however, remained above the RBI’s upper target for the tenth straight month. Since the goal hasn't been met for three quarters in a row, the central bank wrote to the central government last month to explain why it hadn't been met. It did this after holding an extra meeting of the members.

Inflation remains above 6%, and while a respite is expected in November, with the number likely to be 6%, it is expected to rise in the coming months, according to a research note issued by Bank of Baroda on Dec. 4. While global oil prices have come down, the lever is in the hands of the government, which has to take a call on taxes, it said. Otherwise, retail inflation will be unaffected by falling crude prices, the report stated.

"With liquidity being in surplus even now, there may be no overt need to announce a liquidity-inducing scheme, and open market operations can be expected when needed," said the Bank of Baroda note. It also stated that a G-SAP announcement is unlikely because the stance remains one of liquidity withdrawal. 

The Indian economy expanded at a slower pace in the July-September quarter as the base normalised. GDP grew 6.3% year-on-year in the second quarter of FY23, compared with 13.5% in the first quarter, according to official data released last week.

Between December and February, the headwinds to growth may become more evident, and given the lags in monetary policy transmission, the MPC may decide not to hike further, allowing the lagged impact of the cumulative rate hikes to have its desired impact on the real economy and core inflation, Das said. "For another rate hike to happen in February, post the December meeting, the inflation outlook has to deteriorate meaningfully and significant depreciation pressure on the rupee has to re-emerge."

"So the bar for a rate hike in February will be high."