Home / Opinion / Columns /  RBI may hike rate by 25bps; will it be last in this series?

Considering the Reserve Bank of India (RBI)’s discomfort with sticky core inflation, we think the monetary policy committee (MPC) will go for another 25 basis points (bps) rate hike in the February policy. The decision will obviously not be unanimous, but the resolution will still likely pass on a majority vote. We also think the time has come for the MPC to consider changing the monetary policy stance from “withdrawal of accommodation" to neutral, as real rates have turned positive.

According to our own assessment, further rate hikes are not warranted at this juncture, considering that significant front loading has already been done, and real rates are likely to be positive by over 100bps in 1HFY24, with respect to headline consumer price index (CPI) inflation, even at the current policy rate of 6.25%.

But, given that the current drop in headline CPI inflation is led primarily by softening food inflation, and that core inflation is still uncomfortably sticky at 6%-plus levels, RBI may therefore opt for an insurance rate hike, albeit a smaller dose compared to the past.

According to our assessment, with or without this rate hike, core inflation should start to ease from April-June below 6%, and average about 5.5% in FY24; therefore, a rate hike could be avoided at this juncture, as the risk-reward of further rate hikes is more tilted against growth compared to inflation. Our medium-term forecasts show that core inflation will continue to moderate over the next quarters, along with a sequential moderation of growth momentum, which is consistent with findings of past empirical research.

The likely 25bps hike will be accompanied by a downward revision to RBI’s headline CPI forecast. A downward revision is inevitable as October-December 2022 CPI averaged 6.1%, 50bps lower than RBI’s forecast of 6.6%.

We are now forecasting FY23 CPI inflation to average 6.5% in FY23 (versus RBI’s 6.7%), with January-March CPI average likely at 5.5% (RBI’s latest forecast is 5.9%).

Our April-June (DB estimate 4.3% versus RBI at 5.0%) and July-September CPI (DB estimate 4.8% versus RBI at 5.4%) forecasts are also lower than RBI’s CPI forecasts by 60-70bps. Overall, we are forecasting FY24 CPI inflation at 5% with risks biased to the downside.

But how long is RBI expected to pause before cutting the policy rates? In order to answer this question, we analyzed the past two decades’ data to decipher how long the central bank has waited before hiking rates post a rate cut cycle, and cutting rates post a rate hike cycle. We find, the pause period before commencing a rate hike cycle is generally longer (in terms of months) compared to a pause period preceding a rate cut cycle.

Overall, RBI has waited 9-18 months, before starting a rate hike cycle, while the pause period before a rate cut cycle has been 5-11 months, according to our analysis.

Post February, we expect RBI to enter a prolonged pause and then start cutting rates from December 2023 onwards, converging with the US Fed’s rate cut cycle, which would constitute about 10 months’ pause, assuming that the central bank hikes one last time in February.

Our view is that RBI will find it difficult to cut rates unless the US Fed is ready to cut rates.

If the Fed easing cycle gets postponed, compared to our current baseline expectations, then it is plausible that RBI may also consider cutting rates after a few months, so as to not let the interest differential between the repo rate and Fed Funds rate narrow below 100bps.

If the repo rate rises to 6.50% in February, then RBI can consider cutting 100bps between December 2023 and June 2024, bringing the repo rate down to 5.50% by mid next year.

Kaushik Das is managing director and chief economist - India and South Asia, Deutsche Bank, India.

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