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Business News/ Opinion / Columns/  RBI’s policy rate pause is set to continue for long term
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RBI’s policy rate pause is set to continue for long term

While it is important for an emerging economy central bank to stay broadly in sync with the global interest rate cycle, one needs to recognize that, at present, the deviation in case of inflation and GDP growth from their respective trend-lines for Western economies is much more pronounced than in India.

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The status quo on the RBI’s policy rates in April was perfectly in line with our expectation, though sharply in contrast to an overwhelmingly strong market consensus in favour of a 25 basis points (bps) hike. Since then, the swing in the context, backdrop and expectation from the monetary policy committee (MPC) meeting has been dramatic. At present, a status quo on the policy rates in June seems to be a foregone conclusion.

As someone who was clearly in favour of a pause in April, I do not see any reason to change my view in June. The pause by the RBI in April was the most appropriate and commendable decision, demonstrating a more “Fed-independent" monetary policy stance, partly bolstered by the cushion of a material narrowing of trade and current account gaps and a range-bound INR. While it is important for an emerging economy central bank to stay broadly in sync with the global interest rate cycle, one needs to recognize that, at present, the deviation in case of inflation and GDP growth from their respective trend-lines for Western economies is much more pronounced than in India.

Also, trajectories of several key macro variables have changed materially in recent months in a direction that suggests a far lower probability of any more rate hikes in the current cycle. On the inflation front, the RBI’s pause in April was vindicated by subsequent data releases. Retail (CPI) inflation reading for April softened to 4.7% from about 6.5% three months back. While part of the rapid softening admittedly reflected the statistical effects of a high base, it is significant that the headline inflation is comfortably within the central bank’s tolerance band, with relatively little upside risk to the RBI’s CPI forecasts of 5.1% and 5.4%, respectively, for Q1 and Q2 of 2023-24. Thus, the current repo rate of 6.5% implies that India’s real policy rate will hover around over 1% during this period, while maintaining a policy rate differential of about 1.5% with the US.

One should not lose sight that wholesale price (WPI) inflation has turned negative (-0.9% in April) softening from 4.7% three months back. One often feels that WPI inflation in India gets an unduly low level of attention since the adoption of CPI-based inflation targeting despite the rich information content of the former, and the lead property that it often demonstrates over CPI inflation.

In the absence of much debate on the RBI’s potential rate action, the market’s focus in the June meeting will be on: (a) stance of the policy and commentary, in general, (b) guidance on liquidity, (c) any change in growth or inflation forecasts, and (d) operational guidelines, if any.

I expect the RBI to continue with the existing policy stance of “withdrawal of accommodation" with emphasis on continued vigil on inflation and no complacency on growth recovery. One does not expect any material revision in the RBI’s growth and inflation forecasts. Of late, there has been some easing in banking system liquidity for the time being, partly reflecting RBI’s higher-than-expected surplus transfer to the government and considerable amount of accretion to bank deposits triggered by sizeable deposits of INR 2000 notes. Finally, there has been an expectation of the RBI fine-tuning some of the operational guidelines related to banks’ CRR maintenance.

Finally, the central bank will likely continue to reiterate the message of “only a pause and not a pivot" even in June. The undertone of this cautious guidance is that the central bank is in no rush to ease and may even not refrain from hiking again, if needed. However, while the central bank wants to convey that future policy action will remain data dependent, after the pause in April, the bar for further hike in the repo rate has moved higher, especially given the trends in various macro parameters both at home and abroad. Thus, in sum, a pause on the policy rates front for a long while, potentially beyond the current calendar year, is my baseline expectation and the pivot may still be several quarters away.

The author is chief economist & head of research at Bandhan Bank. Views are personal.

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Published: 05 Jun 2023, 10:15 PM IST
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