RBI Pauses Repo Rate Hike – Will it be One-off or a Long Pause?

Dr Debesh Roy, Chairman, InsPIRE

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) on 6 April 2023 unanimously decided to keep the policy repo rate unchanged at 6.5%, “with readiness to act, should the situation so warrant” as clarified by Mr. Shaktikanta Das, Governor, RBI. While major central banks across the world, viz., the US Federal Reserve, Bank of England, European Central Bank, etc., are continuing to tighten monetary policy, albeit at a reduced pace, RBI pressed the pause button.

The RBI has increased the policy repo rate cumulatively by 250 bps in the last 11 months starting May 2022, which was preceded by the introduction of the Standing Deposit Facility (SDF) at a rate 40 bps higher than the fixed rate reverse repo. Therefore, there has been a 290 bps effective rate hike since April 2022. These increases have been fully transmitted to the overnight weighted average call money rate (WACR), the operating target of monetary policy, which has gone up from daily average of 3.32% in March 2022 to 6.52% in March 2023. Hence, the RBI felt it was necessary to evaluate the cumulative impact of these rate hikes. Therefore, the RBI Governor asserted that “it’s pause, not a pivot.”

Further, the MPC in a 5:1 majority decided “to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth”. The RBI Governor argued that “since the inflation rate was above the target and given its current level, the present policy rate could still be regarded accommodative”. In this context, the State Bank of India (SBI) research bulletin Ecowrap, has averred that “RBI has made a clear distinction between policy strategy and policy stance once again and asserted that these can coexist simultaneously. While it has kept the stance same as ‘withdrawal of accommodation’ to calibrate liquidity and ensure that government borrowings face no disruption, its strategy has been changed by hitting the pause button on rate hike”.

The  MPC decided to marginally reduce the consumer price index (CPI) inflation forecast for 2023-24 from 5.3% to 5.2%, assuming a lower annual average crude oil price at $85 per barrel, compared to $90 per barrel earlier, coupled with a normal monsoon. Within a week of the announcement of the monetary policy, the National Statistical Office (NSO)  announced the easing of retail inflation to a 15-month low of 5.66% in March 2023 from 6.44% in the previous month, due to continued moderation in food, fuel, housing and services prices. The retail inflation figure came within RBI’s upper tolerance limit of 6% for the first time in 2023. Importantly, core inflation (which excludes food and fuel inflation) dropped to 5.66% in March 2023 from 6.44% in February 2023, having remained sticky at 6% or above since September 2022. This could give the central bank breathing space for a longer  pause in rate hike. The trend in CPI inflation and core inflation vis-a-vis  repo rate is presented in the following chart.

The expected record rabi production, followed by good kharif production due to favourable monsoon – the first estimate of the India Meteorological Department (IMD), indicating normal monsoon at 96% of Long Period Average (LPA) (although the projection by Skymet indicates slightly below normal monsoon at 94% of LPA) – could lead to a lower inflation trajectory.

The real GDP growth for 2023-24 has been projected by RBI at 6.5 per cent with Q1:2023-24 at 7.8 per cent; Q2 at 6.2 per cent; Q3 at 6.1 per cent; and Q4 at 5.9 per cent, with risks evenly balanced. However, the IMF has cut India’s growth estimate for 2023-24 to 5.9% from 6.1%, citing lesser scope for pent-up demand due to historical revisions to data. The growth projections by Government of India’s Economic Survey, World Bank, ADB, S&P, OECD, ICRA and India Ratings for 2023-24 are 6.5% 6.3%, 6.4%, 6%, 5.9%, 6% and 5.9%, respectively. 

Headwinds like uneven monsoon or elevated crude oil prices at above $90 per barrel, due to the planned cut in production by the OPEC+ countries, could raise inflation, and result in one or two more rate hikes of 25bps each by the MPC during the current fiscal year, till another pause. However, if inflation continues to move southwards, due to record rabi production, normal monsoon,  favourable base effect, and international crude oil prices remaining within $85 per barrel, and also given the recent growth projections, we expect that there could be a long pause in repo rate by the RBI, instead of a one-off one. This could be followed by a rate-reduction cycle, starting as early as April  2024.