RBI has food for thought but likely to keep rate pause

MUMBAI: The Reserve Bank of India’s Monetary Policy Committee (MPC) is likely to keep interest rates unchanged this week while signalling tight liquidity conditions and vigilance on inflation, as rising food prices are seen exerting upward pressure on upcoming consumer price readings.

The MPC, which will detail its next policy statement at the end of its three-day meeting on December 8, is seen keeping the repo rate unchanged at 6.50% while retaining its stance of withdrawal of accommodation, an ET poll of 10 economists showed. After raising the repo rate by 250 basis points (2.5 percentage points) from May 2022 to February 2023, the committee has maintained a pause on the benchmark rate, which is the rate at which the RBI lends to banks.

“We expect a status quo policy both in terms of policy rate and the stance, given the likelihood that inflation in the near term is likely to remain closer to 6%, which is the upper threshold of the MPC’s mandated band of 2-6%. The commentary is likely to remain extremely vigilant on inflation risks despite lower core inflation,” said Anubhuti Sahay, Standard Chartered Bank’s head of South Asia Economic Research.

While inflation based on the Consumer Price Index eased to a four-month low of 4.87% in October, moving closer to the MPC’s target of 4%, the outlook for retail prices in October-December has been clouded by risks of higher food prices. Worryingly for the MPC, weather disruptions in large states such as Maharashtra, Madhya Pradesh, Rajasthan and Gujarat are seen pushing up prices of pulses and onions, which together have a 1.6% weight in the food inflation basket.

Moreover, with GDP growth in July-September outstripping expectations sharply, the RBI may also need to monitor underlying demand conditions in the economy to ensure that inflation risks do not arise from a burst in activity in some sectors. Many analysts expect the RBI to raise its GDP growth forecast for FY24 from 6.5%.

What does provide some solace to the MPC, however, is a sharp decline in core inflation over the past few months, with the price gauge dropping to around 4.20% in October, economists said. Core inflation strips out the volatile components of food and fuel. “We all know that food inflation is going to start rising once again. Under these conditions, there will be a case for pausing on the repo rate. However, given that core inflation is down, there is no reason to increase the rates,” said Madan Sabnavis, chief economist at Bank of Baroda.

The incomplete transmission of previous rate hikes has been a matter that the RBI has publicly spoken of, with central bank economists last month writing that the pace of increase in bank deposit rates had lagged that in lending rates. The RBI has, over the past few months, kept banking system liquidity tight and ensured higher borrowing costs in line with its stance of withdrawing accommodation.

Analysts believe that the central bank has tools to hasten transmission of rate hikes without actually raising the benchmark repo rate.

“Since effective short-term interest rates are already higher at 6.85-6.90% levels versus the repo rate at 6.50% and the standing deposit facility at 6.25% (which is the floor), one option for the central bank could be to raise the SDF rate by 10-15 bps and narrow the corridor with the repo rate, which would be reflective of the central bank’s hawkish stance, without hiking the repo rate,” Kaushik Das, chief economist-India and South Asia at Deutsche Bank, wrote in a November 30 note.

RBI governor Shaktikanta Das had sent sovereign bond yields surging by saying in the October policy statement that the central bank would conduct standalone open market sales of government bonds to drain excess liquidity. While the RBI has yet to carry out such bond sales, the central bank’s commentary on the same is keenly awaited.

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