Reading RBI’s Policy Review
Present circumstances:
- The Monetary Policy Committee recently voted 4-2 to increase the policy repo rate by 25 basis points, to 6.5 percent (MPC). Even though this rise is less significant than the previous 35–50 bps strong hikes, it was necessary to raise the interest rate in order to bring inflation back to the desired 4% level.
- The two main focuses of monetary policy in an economy are money supply and cost (interest rates).
- The MPC of the RBI meets every two months to assess the state of monetary activity. In order to reduce price volatility while maintaining a reasonable inflation rate, the MPC may alter the repo rate, which is the interest rate at which the RBI loans to commercial banks, during these sessions.
An essential analysis of monetary policy:
- The most recent monetary policy review was important for a variety of reasons.
- One is that it followed the Union Budget, the most important declaration of fiscal policy for the year, in its announcement.
- As a result of the allegations made against the Adani Group by Hindenburg Research and the resulting volatility in the price of Adani’s stock, it occurred at a time when the Indian stock market was already unsteady.
- Three: At the moment, central banks throughout the world are either slowing down the rate of increase in interest rates or possibly considering discontinuing monetary tightening.
- Finally, as this was the last review of the current fiscal year (2022-23), it provided a wonderful opportunity to understand how the RBI expected the Indian economy to develop in the subsequent fiscal year (2023-24), for which the Budget has just been unveiled.
RBI’s announcement:
- The choice of the repo rate and the “stance” of the policy are the two halves of any monetary policy.
- Changes in the repo rate have an effect on the entire economy by determining whether loans for homes, cars, or businesses will be more expensive or less expensive, but the policy positions of the MPC members reveal the members’ views on the inflation and economic growth outlook.
- As retail inflation has been beyond the RBI’s comfort zone of 2% to 6% for 10 of the past 12 months, the position has been concentrated on “removing stimulus to ensure that inflation remains within the target ducing forward, while sustaining growth.”
- The MPC’s opinion that inflation has slowed down more swiftly than anticipated was reflected in the MPC’s decision to raise the repo rate by 25 basis points, which was less than the rate’s previous rises of 50 and 35 bps.
- It also implied that the current cycle of interest rate increases in India, which began in May of last year following a retail inflation peak of almost 8% in April 2022, may be coming to an end.
- According to RBI Governor Shaktikanta Das, consumer price inflation in India went below the upper tolerance limit (i.e. 6%) for the months of November and December 2022.
On the increase, the MPC is split:
- The rise was rejected by the government-nominated MPC members Ashima Goyal and Jayanth Varma by a vote of 4-2 in favour.
- In fact, it was thought that since inflation is falling more swiftly than expected, the RBI should delay raising rates. It was widely recommended that the RBI postpone interest rate rises until it was obvious how previous rate increases had hurt the economy and left some room for growth.
- It was predicted that the RBI would take a “neutral” stance, which would indicate that it no longer wants to formally raise interest rates and would instead prefer to see how things play out.
- But in this instance, the MPC once more opted to maintain the status quo.
- Simply put, the RBI’s decision to come out as more “hawkish” startled many (i.e., concerned more about rising inflation than the deceleration in economic growth).
Why RBI took a hardline stance:
- The answer may lie in the RBI’s forecasts for inflation and economic growth in India for the ensuing fiscal year. The RBI expects India’s GDP to grow by 6.4% in FY24, however the rate of expansion would gradually slow throughout the year.
- “Real GDP growth for 2023–24 is estimated at 6.4% with Q1 at 7.8%, Q2 at 6.2%, Q3 at 6.0%, and Q4 at 5.8%,” the MPC’s policy statement reads.
- From the 7% growth rate it is projected to achieve in the current fiscal year and the 8.7% growth rate it attained in the previous fiscal year, India’s growth rate would decline somewhat to 6.4% from those levels. But most experts who expected the RBI to stop raising interest rates think that GDP growth will barely, if at all, reach 6%.
- Although the RBI does not place a high premium on India’s GDP growth, its inflation outlook is more positive than is usually thought.
- Retail inflation is expected to be 5.3% through 2023–2024, and it won’t go below 5% in any of the next four quarters, according to the RBI.
Conclusion:
- The RBI is nonetheless concerned about the core inflation rate (or the rate of inflation when prices of food and fuel are taken out of the calculation).
- It is clear that the effects of higher food and gasoline costs have permeated the rest of the economy because core inflation is currently hovering around 6%.
- Bringing down high core inflation often takes longer than lowering headline inflation because the cost of food and fuel can fall as fast as it can increase.
