RBI Monetary Policy: Repo Rate Hike by 25 Bps, As Concerns for Core Inflation Remain

Dr Debesh Roy, Chairman, InsPIRE

The Reserve Bank of India (RBI) raised the policy repo rate by 25 basis points (bps) to 6.5% on 8^th February 2023.  The Monetary Policy Committee (MPC) of the RBI in a 4:2 majority decision flagged the stickiness of core inflation as the reason behind the hike, although headline CPI inflation has been sliding below RBI’s upper tolerance limit of 6% since November 2022. Considering the slowdown in headline inflation, the hike in the repo rate has been reduced to 25 bps from 50 bps in October 2022 and 35 bps in December 2022. The observations of RBI Governor Shaktikanta Das that “we need to see a decisive moderation in inflation” could be an indication that the MPC is not done with the hike cycle yet. However, there could well be a pause in the repo rate in the next MPC meeting in April 2023, assuming further decline in retail inflation in January and February 2023.

The MPC has indicated a mixed outlook for inflation. It has stated that: “while prospects for the rabi crop have improved, especially for wheat and oilseeds, risks from adverse weather events remain.” The MPC also expects that commodity prices could face upward pressures with the easing of COVID-related mobility restrictions in some parts of the world. Further, the ongoing pass-through of input costs to output prices, especially in services, could continue to exert pressures on core inflation. The RBI’s enterprise surveys indicate some softening of input cost and output price pressures in manufacturing. In view of these factors and also assuming an average crude oil price (Indian basket) of US$ 95 per barrel, the MPC has projected inflation at 6.5% in 2022-23, with Q4 at 5.7%. Further, assuming a normal monsoon, CPI inflation is projected at 5.3% for 2023-24, with Q1 at 5.0 per cent, Q2 at 5.4%, Q3 at 5.4% and Q4 at 5.6%, and risks evenly balanced.

Further, MPC has projected real GDP growth for 2023-24 at 6.4% with Q1 at 7.8%, Q2 at 6.2%, Q3 at 6.0% and Q4 at 5.8%, and risks broadly balanced. This could be possible due to the following factors: (i) Stronger prospects for agricultural and allied activities which could boost rural demand; (ii)The rebound in contact-intensive sectors and discretionary spending is expected to support urban consumption; (iii) Businesses and consumers surveyed by the RBI are optimistic about the outlook; (iv) Strong credit growth, resilient financial markets, and the government’s continued thrust on capital spending and infrastructure would create a congenial environment for investment. However, on the flip side, there could be an adverse impact on exports, due to tepid external demand on account of a slowdown in global activity.