Belying expectations, the Monetary Policy Committee (MPC) delivered a fairly hawkish policy on Friday, by hiking the repo rate by 50 basis points and continuing to withdraw accommodative liquidity conditions. By offering no forward guidance on its future rate actions, the MPC also dashed the market’s hopes for smaller rate hikes or a pause later this year. The MPC’s actions were, however, consistent with its own growth and inflation projections. Despite the recent moderation in select commodity prices, the RBI has retained its inflation forecast for FY23 at 6.7 per cent, assuming that the average price of the Indian crude oil basket would remain elevated at $105 a barrel. The RBI expects CPI inflation to decline from 7.1 per cent in Q2 FY23 to 5 per cent by Q1 FY24, but has indicated that it wouldn’t be satisfied with inflation falling below 6 per cent and would be looking to bring it down to 4 per cent — the mid-point of its target range. The central bank has taken an upbeat view on the economy despite gathering global headwinds. The statement points to higher capacity utilisation for manufacturing and the pickup in high-frequency services indicators to retain the FY23 GDP growth forecast at 7.2 per cent.

Admittedly, market expectations for a soft policy this time around were unrealistic. Retail inflation has stayed above 6 per cent for six months in a row. Though prices of some industrial inputs have moderated, global energy prices remain a wild card factor, with geopolitical tensions on the China-Taiwan front now adding to Russian supply disruptions. There’s also the elephant in the room in the form of India’s shrinking interest rate differentials with the West. With the US Fed, European Central Bank and the Bank of England embarking on concerted rate hikes to quell inflation, the RBI could not afford to risk further capital outflows at this juncture that could make it tougher to bridge the widening current account deficit (CAD). The central bank has put on a brave face, striking a confident note on the external situation while attempting to talk up the rupee by referring to India’s sound debt-servicing ability and ‘strong umbrella’ of forex reserves. That worries about the external situation and currency remain at the forefront in policy deliberations is evident from the MPC statement discussing these concerns at length.

Overall, it is becoming increasingly likely that India’s growth-inflation dynamic could diverge significantly from that of the advanced economies which are staring at a stagflation scenario in the coming months. Domestic economic activity seems to be in recovery mode while food inflation could ease if the monsoon delivers. The RBI’s policy rate is already above pre-pandemic levels, with the impact of the 140-basis point increase taken in the last three months likely to impact investments and spending over the next two quarters. All this makes it necessary for the MPC to chart an independent path on rate actions which can keep India’s growth impulses alive while managing inflation expectations. The ever-present threat of capital outflows makes this a difficult trade-off. But announcements accompanying this policy, allowing the Bharat Bill Payment System to accept cross-border payments from NRIs and opening up the offshore rupee market to standalone primary dealers, show that non-monetary steps to manage the rupee are feasible. More innovative thinking is needed on these lines so that India’s rate actions don’t need to toe the Western line.