The Reserve Bank of India (RBI) Governor Shaktikanta Das said in his post-MPC statement on Wednesday that the repo rate hike of 35 basis points (50 basis points last time at the end of September) was in line with market expectations. Well, almost. A definite body of opinion, which included an MPC member, felt that a pause this time would have been a better option; the 190 basis points hike since May needed time to transmit itself into the system. The repo rate of 6.25 per cent now is at its highest since February 2019.
Das said in his speech that the weighted average lending rates on fresh rupee loans have increased by 117 basis points and on fresh deposits by 150 basis points. The latter points to the pressing need for banks to raise deposits to meet rising credit demand, which in turn suggests the return of growth impulses. However, given this speed of transmission, the effect of a 225 basis points hike may be sharply felt towards the busy fourth quarter, just when business activity and investments pick up. That said, the compulsions behind raising rates now are understandable. The inflation projections are unchanged over the last MPC meeting held two months back, at 6.7 per cent for FY23, but a projected inflation rate of 5.4 per cent for Q2 of FY24 suggests that concerns remain elevated — given the fact that the RBI, as conceded by Das in his speech on Wednesday, would be comfortable with inflation at 4 per cent. For the present, ‘sticky core inflation’ (a demand-pull phenomenon) is a concern, besides imported inflation. Inflationary expectations have to be fully neutralised too. Therefore, the role of a 35 basis points hike in anchoring demand-driven inflation, even if it is confined to a segment of the economy, cannot be wished away.
As for the global angle, Das surprisingly said, “the outlook for the US dollar and hence imported inflation also remains uncertain”, while wondering when Fed would arrive at its terminal rate. Despite portfolio flows resuming in recent months, remittances looking up and the rupee being stable, the RBI seems averse to widening the interest rate differential.
The RBI’s commentary and stance signal that further hikes are not ruled out and will be contingent on the nature of the incoming data, which is just as well. Interest rates should not choke off investment, just as inflation should not throttle consumption. While trying to fix the latter, it is important to note that supply-side inflation of essentials has little to do with rate hikes. The Governor has taken a sanguine view on growth, despite reducing the FY23 growth forecast by 20 basis points over the September policy to 6.8 per cent. Das has pointed to robust consumption and investment demand. However, the Q2 GDP figures show private consumption almost unchanged over the last quarter (at ₹22 lakh crore in both periods). Post-Covid pent-up demand may peter out if investment does not look up. Given limited fiscal headroom, private investment can make or mar GDP prospects. The MPC should keep this in mind.