RBI policy review: Markets rejoice at the temporary pause

Despite the headline inflation remaining far above 6 percent in the previous two months, RBI's decision to stop rate increases shocked the markets. The "withdrawal of accommodation" posture was maintained, but it left itself with other options

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Zainab Ashraf
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RBI Governor Shaktikant Das Economy

RBI Governor Shaktikanta Das (File Photo)

New Delhi: The situation for central banks around the world is difficult. Economies around the world are still working hard to keep inflation stable, while also being clearly wary of warning signs of stress in the financial system.

Most economies are focused on their main goal of keeping inflation under control. For example, as part of a recent RBI policy, the US Federal Reserve raised its benchmark interest rate by 25 basis points (or one percent) in March 2023.

The Bank of England also raised interest rates by 25 basis points. In March, the European Central Bank also raised interest rates by 50 basis points.

Contrary to expectations, the Reserve Bank of India (RBI) decided against continued interest rate hikes. Despite headline inflation remaining well above six percent for the past two months, the Fed decided to hold off on raising rates, which surprised the markets. The “withdrawal of accommodation” posture was maintained, but it left itself with other options too.

According to RBI, the battle against inflation is ongoing. Following China's economic recovery, there are new concerns about inflation, such as the significant increase in crude oil prices, which has brought about a boost in the country’s demand situation. Additionally, the OPEC+ nations announced output reduction will result in a less supply of oil, which will help to support its price.

The Indian share market is elated at RBI’s decision to call off rate hikes for the time being. After the RBI Governor Shaktikanta Das ordered a halt to rate increases and expressed optimism regarding the nation’s economic development and inflation trajectory, the Sensex increased by more than 250 points.

RBI Governor Shaktikanta Das said, “India’s real gross domestic product (GDP) is expected to have recorded a growth of 7 percent in 2022-23. Hence, economic activity remains resilient. Real GDP growth for 2023-24 is projected at 6.5 percent, with Q1 at 7.8 percent, Q2 at 6.2 percent, Q3 at 6.1 percent, and Q4 at 5.9 percent. The risks are evenly balanced. CPI (retail) inflation is projected to moderate to 5.2 percent for 2023-24, with Q1 at 5.1 percent, Q2 at 5.4 percent, Q3 at 5.4 percent, and Q4 at 5.2 percent.”

It's just a pause; not a cut

Market participants are very relieved that interest rates have stopped rising. However, we must bear in mind that the fight against inflation is not over yet and the RBI’s next actions are based on facts. Also, this is just a pause, not a reduction, so rates are still higher than they should be.

Rate increases in the US may reach a top of 5.25 percent since the current banking crisis necessitates careful calibration. However, if that changes, developing markets would become more susceptible, and RBI will respond by raising interest rates more if necessary to account for the uncertainty. It is important to pay attention to import inflation pressures and the growing unpredictability of global financial markets.

Furthermore, RBI would need to reconsider its decision if crude oil prices continue to rise for a protracted period of time. The central bank may continue its halt, though, if inflation stays under control, as the RBI anticipates. In 2023, a rate reduction is improbable.

The RBI's decision to take a break appears to indicate that the government's main bank anticipates slower inflation and GDP. With this, it appears that the RBI's cycle of rate increases is at an end. It is highly likely that the RBI will continue to operate in pause mode throughout 2023 barring a significant surprise in GDP or inflation. This was a tightening policy as we are concerned about inflation, especially core inflation, and aim to hit our medium-term target of four percent.

The RBI MPC is anticipated to continue its prolonged pause. Given our growth-inflation projection and the effects of previous rate hikes on the same, there is limited room for additional increases.

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