RBI to revert to baby steps approach to monetary tightening

The central bank, which effected six back-to-back hikes in the key short-term lending rate (repo) since May 2022 to check high inflation, decided to pause early this month.

The Reserve Bank of India’s rate-setting panel is likely to revert to tightening monetary policy through the so-called baby steps, namely rate hikes of 25 basis points, according to an economist.

“The RBI continued frontloading policy tightening in its late-September meeting with another 50bp hike to the repo rate (to 5.90 percent) but communications since then suggest that some MPC members are ready to ease off the brakes,” Shilan Shah, Senior India Economist at Capital Economics said in a note.

India’s Monetary Policy Committee has raised the key policy repo rate by 190 basis points since early May as it shifted focus to inflation from growth. The panel, which had kept the repo rate at a record low 4 percent for two years, has been raising it by 40 basis points to 50 basis points at its last three meetings. Before pandemic, typically, the rates used to be shifted in tranches of 25 basis points.

Meanwhile, the most hawkish member of the MPC, Prof Jayant Varma, advocated in the minutes of the latest meeting that “a pause is needed after this hike” because “much of the impact of large monetary action is yet to be felt in the real economy”.

Another member Ashima Goyal, considered as the most dovish MPC member, voted for a smaller hike as “high uncertainty calls for small steps”.

Also read: RBI rate hikes to contain price rise; inflation to fall below 6% next year: MPC member Ashima Goyal

All this appears to take two votes for another 50 basis points hike off the table in the next meeting in December, Capital Economics’ Shilan Shah said.

“And by then, we think other MPC members will have seen enough evidence of growth coming off the boil and price pressures peaking,” he added.

The house expects India’s repo rate to top out at 6.40 percent early next year.

Also read: Rising inflation, manufacturing slowdown poses new challenge for India

To be sure, India’s central bank has failed to meet its price mandate, with the retail inflation for September confirming a third straight quarter in which average inflation stayed outside the tolerance band of 2-6 percent.

Retail inflation rose to 7.41 percent in September from 7.00 percent in August.

Though it is likely to drop back, the headline inflation print will remain above the ceiling of the RBI’s target range for several more months, according to Capital Economics.

Monetary policy works with a lag with actions taking three-to-four quarters to have an impact. The government has also been taking several supply-side measures to ensure food prices remain in check.