Improved inflation outlook leads to slower pace of rate increase

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) raised the repo rate today by 25 basis points (bps), taking it to 6.50%. The decision to slow its pace of hike (from the previous instances of 35 bps and 50 bps) is in line with the improving inflation outlook. Yet, a calibrated monetary policy action of a smaller quantum was warranted to ‘break the persistence of sticky core inflation’ and anchor inflation expectations. Indeed, the moderation seen in headline inflation in the past two months was largely driven by sharp correction in vegetable prices (the most volatile in the inflation basket), even as core inflation remains sticky at 6%.

The governor’s statement underlined that while inflation has come within the central bank’s tolerance range of 2-6%, it remains above its medium-term target of 4%. Hence, the MPC’s actions can also be seen through the prism of ensuring inflation eventually aligns to this target. That said, the RBI’s current forecast does not foresee inflation below 5% in any quarter of the next fiscal. But the average inflation forecast of 5.3% for the next fiscal (compared with 6.5% this fiscal), puts it on a declining glide path.

The smaller quantum of rate hike by the central bank is a nod to moderating inflation and improved inflation outlook, while recognising the risks arising from core inflation. We expect this to be a terminal hike in the current cycle, and the MPC to pause thereafter to assess the impact of rate hikes so far. Sticky core inflation could mean that the repo rate could remain at 6.5% for longer. The latest decision is also in alignment with actions of a few central banks that have slowed or paused rate hikes in the past few months, as inflation is now on a descent globally.

Highlights of the February meeting

• The MPC voted with a 4-2 majority to raise the policy rate by 25 bps, taking the repo rate to 6.5%, standing deposit facility rate to 6.25% and marginal standing facility rate to 6.75%
• The monetary policy stance was maintained at ‘withdrawal of accommodation’, again with a 4-2 majority
• The MPC maintained its downwardly revised forecast for Consumer Price Index (CPI) inflation at 6.5% for this fiscal (from 6.7% earlier)