How Budget 2023 paves the way for RBI to pause rate hike after February

RBI Governor Shaktikanta Das

If you thought the good news stopped with the Budget 2023 slashing the tax burden on individuals, think again. The budget proposals are also likely to help stop the interest rate hikes by the Reserve Bank of India that have been raising your EMIs since last year.

The Budget’s fiscal rectitude would be music to the ears of the members of RBI’s interest rate-setting panel. Finance Minister Nirmala Sitharaman not only met her deficit target for the current fiscal year and announced a lower target for the next but she also said that she would stick to the medium-term aim of below 4.5 percent of the GDP.

The RBI’s monetary policy committee, which has been waging a war on red-hot inflation over the last year, is widely expected to raise interest rates by another 25 basis points when it meets February 6-8.

The panel has raised interest rates by 225 basis points since April 2022. In October, the central bank failed to meet its inflation mandate after headline retail inflation stayed higher than its tolerance band of 2-6 percent for three quarters in a row.

One basis point is a hundredth of a percentage point.

While inflation has come back within the target band since then, it has spent well over three years above the RBI's medium-term target of 4 percent. RBI management is sanguine that the price gauge will cool down to target over two years.

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Hitting pause on rate hikes

But next week will see another rate hike before the pause.

“We can expect to see further central bank action from the Reserve Bank of India on 8 February. The current repo rate is at 6.25 percent, which is 55bp higher than the prevailing rate of inflation, which has since fallen back into the top end of RBI’s 2-6 percent tolerance range,” Robert Carnell, Regional Head of Research, Asia-Pacific at ING, said in a note.

“Our contention has been that the RBI is at or close to the peak, and we believe that the RBI will put a pause on the hikes to give growth a chance.”

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Two to tango

To be sure, India’s fiscal and monetary policies have acted in lockstep since the coronavirus pandemic hit.

At the start of 2020, the central bank slashed interest rates to a record low and infused a hefty amount of liquidity into the banking system, while New Delhi focused on restrictions and targeted relief.

Over the course of the pandemic, which raged across the sub-continent, the government gave free foodgrains to the most vulnerable, a scheme that was partially discontinued only in December 2022.

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On the other hand, the central bank provided succour through steps such as a one-time delay in certain loan repayment, a one-time restructuring for certain borrowers and so on.

When food costs and supply chain dislocations pushed inflation higher, the government and central bank also worked together. After looking through the initial spike in prices over several months, the central bank finally started raising rates as global inflation also reared its ugly head.

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The government announced a slew of measures to curb imported inflation and control local food costs. It also twice lowered duties on fuels to contain second-round effects.

Now, the government has held off fiscal expansion, which was the big theme in the pandemic years. This should help the RBI as it waits for the impact of the earlier rate hikes to play out.

“As the Budget maintains fiscal prudence and the inflation trend is moderating, we expect the RBI to deliver a final rate hike in the February policy review and change its stance to neutral,” Upasana Chachra, Chief India Economist at Morgan Stanley, said in a note.