Quick Take | High real rates are a clear reason for RBI to pause

It is yet another indicator that will prompt the Monetary Policy Committee (MPC) to take rate hikes off the table when it announces its interest rate decision on December 5. To be sure, this is the real interest rate based on past data and the rate setting panel would like to consider the policy rate adjusting for inflationary expectations.

Inflation expectations, however, have remained on the higher side in India, even during those periods when actual inflation has trended down. One reason for this is the Reserve Bank of India’s track record of being conservative in its own estimates, a reason why some economists have called for an overhaul of its inflation projection models.

On the flip side, the indications for inflation to trend down further are strong. Despite the strong showing of the November Purchasing Managers’ Index, the consensus suggests that demand is weakening. The fall in crude prices, by around a third since the last RBI policy meeting, and the strengthening of the rupee will further reduce inflationary risks. That could lead to RBI paring its inflation estimates for the second half of this fiscal and likely softening of inflationary expectations as well.

In any case, these factors, plus a growth slowdown, especially as rural distress deepens, should prompt the rate setting committee to reverse the monetary policy stance to neutral from the current mode of 'calibrated tightening'. A neutral stance indicates that further rate hikes are not a given but that interest rate moves in either direction would depend on data.