RBI’s decision to pause rate hikes amid inflation concerns
- The RBI has decided not to increase the repo rate due to continuing hikes by important central banks like the US Federal Reserve and European Central Bank, and domestic inflation concerns.
- The decision is subject to change if incoming data suggests rising inflation risks.
Assessment of impact of rate hikes on money market rates
- The RBI feels that money market rates have effectively risen more than the 250-basis-point yank in the repo rate since May 2022.
- The RBI has decided to pause and assess the impact of rate hikes.
- Expected decline in inflation and upside risks
- The key reason behind the MPC decision is the expectation of a decline in inflation to 5.2% in the current fiscal year.
- The decline is driven by a healthy rabi crop, normal monsoon, moderating international commodity prices, and the impact of rate hikes.
- The RBI acknowledges the upside risks and is ready to fight any unexpected rise in inflation.
Impact on GDP growth
- The RBI expects GDP growth to slow to 6% from 7% this fiscal year.
- Slowing global growth, domestic interest rates, and messy geopolitics are expected to bite.
- Slowing global growth will be a net negative for India’s exports, and the growing dependence on commodity exports makes India more vulnerable to global growth volatility.
- Fiscal 2024 will test the resilience of India’s domestic demand amid rising interest rates.
Reasons for expected cooling of consumer inflation
- Fuel inflation expected to reduce to 3% from a high of over 10% in the current fiscal year due to some easing of crude oil prices as global growth slows down.
- Slowing domestic growth will ease core inflation from very sticky levels of over 6% last fiscal year to 5.5% in the current one.
- However, the decline in core inflation will be limited as input cost pressures have not dissipated.
- Food inflation, which has a high weightage in the Consumer Price Index and has driven headline inflation in the past, is projected to moderate to slightly below 5% assuming a normal monsoon.
- Food inflation has always been volatile and carries upside risks largely because of climate-related factors affecting agriculture output and prices.
Impact of growth slowdown in US and Europe
- US and Europe have twice the GDP of China
- Slowdown in US and Europe will have a deeper impact than China’s recovery
- This will hurt India’s exports to US and Europe
- India’s exports to US and Europe are more than to China
- India exports more to US and Europe than to China by a factor of six
- Negative impact of growth slowdown in US and Europe will be felt more by India than by China
- India’s growing dependence on commodity exports
- India’s exports of petroleum products and steel are growing
- This makes India more vulnerable to global growth volatility
- As global growth slows down, demand for commodities is likely to decline, which will hurt India’s exports
- External vulnerabilities
- India’s external vulnerability is expected to decline
- Narrower current account deficit and modest short-term external debt
- CAD is expected to narrow to 2% of GDP this fiscal from 2.5% last fiscal
Conclusion
- RBI’s decision to pause rate hikes is driven by expectations of a decline in inflation
- Inflation risks remain and rate hikes could impact GDP growth significantly
- India’s external vulnerabilities are expected to decline, but banking turmoil and elevated debt levels remain a risk
- RBI’s decision to pause rate hikes will be closely watched and further rate hikes may be necessary if inflation risks persist.