Expect another rate hike as RBI keeps tab on inflation
If the worst of inflation is behind us, as the RBI just confirmed, we must be a few steps away from the endgame of the ongoing rate hike cycle. The first hint arrived on Wednesday when the central bank reduced the quantum of rate increases from 50 bps to 35, acknowledging that inflation is indeed cooling down. However, the captain of caution, Governor Shaktikanta Das, dutifully reminded us that our battle against price rise wasn’t yet over. Global commodity and crude prices are easing, but given the geopolitical uncertainties, further price shocks aren’t completely ruled out. Moreover, like interest rates, which rise quickly but correct gradually, inflation too peaks in an eye blink but moderates in what appears like a lifetime. The RBI now estimates inflation to average 5–5.25% in the first half of the next fiscal, which is well below the higher tolerance level of 6%, but away from the mandated 4% target.
Globally, the chorus for ending the tightening cycle is getting louder. Only last month, US Federal Reserve Chair Jerome Powell indicated a willingness to reduce the pace of rate hikes starting this month. The trend is visible among economies. As per private estimates, eight central banks delivered 400 bps rate hikes in November, down from 800-plus bps in June and July. Curiously, rate hikes were much sharper in emerging markets than in advanced economies to avoid interest rate differential that upsets foreign investment flows. But as Das noted, India’s monetary policy will be dictated only by domestic inflation and growth dynamics and not by peer central bank actions. In other words, RBI is unmindful of the widening interest rate differential, having raised rates by a cumulative 225 bps against the Fed’s 350 bps increase.
Assuming a headline inflation of 5–5.25% in the next fiscal, RBI’s terminal rate is seen at 6.25%. It’s the point where the repo rate is anchored before the rate cut cycle begins. Analysts expect the February policy decision to be “finely split between a pause and a last 25 bps hike” with a bias towards a hike considering the sticky core inflation. That said, as economists at HDFC Bank observed, when a central bank combines its sanguine view on growth with continued concerns on inflation, it suggests the battle-readiness to raise rates at will. RBI’s reluctance to shift to a neutral stance further validates its bias towards hikes for now.