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As central banks globally slow their tightening of monetary policy amid data on inflation coming off last year’s peaks, the Reserve Bank of India (RBI) seems to be following in step. On Wednesday, its monetary policy committee (MPC) raised its repo rate by 25 basis points to 6.5%, slowing its pace from December’s hike of 35 basis points. Other policy rates went up in tandem. But our central bank did not shift its stance. It remains “focused on withdrawal of accommodation". In January, it absorbed surplus liquidity of about 1.6 trillion on a daily average, and the peak rate on the May-onwards repo incline likely lies further ahead, with at least another hike in store. As retail inflation had fallen below RBI’s 6% upper limit in the last two months of 2022 and was projected at 5.3% in 2023-24, and with growth looking harder fought next fiscal year, some observers expected a ‘neutral’ stance, with rates put on pause. However, as Governor Shaktikanta Das made clear, core inflation is still too sticky. This hawkish tone also stems from sensitivity to the role of people’s expectations. After last year’s failure on price stability, this is an emphasis well judged. It suggests an RBI committed to meeting its 4% medium-term target for inflation, as distinct from being content with a rate under 6%. Inflation targeting, after all, needs to shore up its credibility.

Sure, if RBI overdoes its policy withdrawal, an approach it signalled last April with a switch away from its covid accommodation, it may put India’s economic recovery at risk. The central bank seems to be counting on the resilience of our economy. In support of this view, it cited buoyancy in urban consumption, as seen in passenger vehicle sales, domestic air traffic, tourism and hospitality, among other indicators. Yet, at 6.4%, its GDP growth forecast for 2023-24 may turn out more rosy than realistic, especially if flagging global growth takes a bigger toll than anticipated. If so, RBI may have to reassess its policy. Right now, credit is looking up; what matters is the confidence of investors in obtaining real returns that exceed their real cost of capital. Under today’s dynamics of post-pandemic normalcy, business prospects rather than cheap loans ought to drive investment, making space for RBI to fulfil its legal mandate of keeping our cost-of-living in control.

Inflation needs to be held at 4% for a sustained period once it’s tamed for RBI to consider itself successful. Else, a rupee whose true value is wobbly will cause inefficiencies all around on account of the ‘money illusion’ it creates, making macro stability a challenge and acting as a drag on output expansion beyond the short-term. What’s more, while India does not have wage-push pressures like America does, RBI has to watch the impact of widened asset-yield differentials with the US each time the Federal Reserve tightens its own policy. This factor may also have tipped the scales in favour of tighter money in India, exposed as we are to dearer imports if capital outflows weaken our currency further. Thankfully, food prices have cooled lately and fuel may have turned benign. Last year, these items were inflamed by war-led scarcities and its effect worked its way around to heat up the core rate of inflation. At this juncture, all taken into account, RBI has done well to keep its monetary squeeze going. With the government’s fiscal deficit set to tighten only slightly in 2023-24 and its borrowing plan still quite huge, RBI’s bond market actions will serve as subtle signals of its resolve.

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