RBI Policy | Repo may remain unchanged, but rate lift-off not far as inflation noose tightens

RBI Governor Shaktikanta Das (Image credit: ANI/Twitter)

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) may leave the repo rate unchanged and retain its accommodative stance for the 11th consecutive meeting on April 8, but an interest rate lift-off has edged closer than ever in the pandemic era.

A Moneycontrol survey of 12 economists showed respondents were unanimous in their belief that the central bank's rate-setting panel will retain the repo rate at its record-low level of 4 percent later this week. However, elevated inflation levels will force the central bank to acknowledge the risks from rising prices and raise its inflation forecast significantly.

The MPC began its three-day meet on April 6. Its decision is expected to be announced by RBI Governor Shaktikanta Das at 10am on April 8.

"Based on the macro and geopolitical developments after the last monetary policy meeting on February 10, we think the MPC should definitely change the monetary policy stance to neutral from accommodative in the upcoming meeting on April 8 and raise the reverse repo rate by 40 basis points as well," noted Kaushik Das, Deutsche Bank's chief economist for India and South Asia.

"But given the dovish disposition of the committee, it is more likely that a status quo will be maintained once again as far as the stance and reverse repo rate are concerned," Das added.

Data released on March 14 showed Consumer Price Index (CPI) inflation rose to 6.07 percent in February from 6.01 percent the previous month. And economists see inflation rising even further in March - data for which will be released on April 12 - to as much as 6.5 percent, which would make it the third consecutive month in which it would come above the upper bound of the RBI's 2-6 percent mandate.

The RBI's inflation forecast of 4.5 percent for FY23 has been heavily criticised from the day it was first released on February 10. Since then, Russia's invasion of Ukraine has sent global commodity and energy prices soaring, upending most estimates.

A median of 1- economists' forecasts showed CPI inflation is expected to average around 5.8 percent in the current financial year. This means the RBI will likely make a massive upward revision to its forecast.

"Since the February MPC meeting, Brent crude is up 21 percent, domestic petrol, diesel pump prices are up 6.5 percent, the domestic LPG (Liquefied Petroleum Gas) cylinder price is up 6 percent, commercial LPG price is up 12.5 percent, retail edible oils prices are up around 12 percent," Bank of America Securities said in a report on April 4.

Bank of America Securities sees CPI inflation averaging 5.5 percent this financial year, with upside risk of 30 basis points.

Lift-off imminent?

The MPC has been battling market expectations for some time now, with economists saying it has been slow to normalise the extraordinarily loose monetary conditions and has fallen ‘'behind the curve'.

The source of this divergence has been the committee's focus on growth, with its statement in February reiterating that the stance of monetary policy would remain accommodative "as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy, while ensuring that inflation remains within the target going forward".

However, the minutes of the February 8-10 meeting of the MPC showed certain members seemed to be warming up to the idea that a policy rate lift-off is not far away.

But that was before Russia's invasion of Ukraine.

The RBI said in February it expects GDP growth to come in at 7.8 percent in FY23. This could be revised down to 7.5 percent this week, per economists' estimates.

According to India Ratings, the fall in India's growth this year will depend on how long crude oil prices remain elevated.

"In Scenario 1, the crude oil price is assumed to be elevated for three months, and in Scenario 2, the assumption is for six months, both with a half cost pass-through into the domestic economy. Ind-Ra (India Ratings) expects GDP to grow 7.2 percent in Scenario 1 and 7.0 percent in Scenario 2 in FY23, compared to its earlier forecast of 7.6 percent," Sunil Kumar Sinha, India Ratings' principal economist, said in a note on March 30.

While there are downside risks to growth, the MPC may have to raise interest rates before long.

According to Morgan Stanley, the RBI will raise the reverse repo rate by 15-20 basis points on April 8 and follow it up with a repo rate hike in June. In total, Morgan Stanley expects the repo rate to be increased by a huge 125 basis points in FY23.

Although others are not as hawkish, the rate hike cycle is widely seen starting in the next couple of meetings.

Crucial to preparing the ground for such a change in policy will be the stance and the language used by the MPC in its statement, particularly in light of Governor Shaktikanta Das saying in February that the RBI's actions will be "calibrated and well telegraphed".

"So, as and when we decide on something, we will spell it out, we will give guidance and it will be calibrated. We don't like suddenness and sudden surprises," Das had said.