JOIN USMonetary Policy | Unexpected pause, but it’s far from boring
One wishes the Reserve Bank of India (RBI)’s monetary policy to be boring, but it has rarely been the case — at least in the last 15 years. As an economics teacher, every semester I tell students that we are facing some or the other crisis. As crises keep coming thick and fast, the monetary policy as a crises solver is far from boring. The April 2023 monetary policy is no different.
The global economic environment, especially financial stability outlook, turned adverse in March with bank failures in the United States and in Switzerland. The OPEC also added to the economic misery by cutting down oil supplies leading to higher oil prices and future inflation.
Not that economic conditions were any better before the banking crisis. The International Monetary Fund (IMF) in its World Economic Outlook in October, said that growth rates will stall in three largest economies: the US, Euro-area, and China. In January, the IMF updated and revised the growth outlook upwards mainly due to China reopening its economy after stringent COVID-19 lockdowns in 2022. While the outlook improved, the risks remained on the downside.
One of the downside risks mentioned by the IMF was ‘financial markets could also suddenly reprice in response to adverse inflation news’. This was prophetic, as in March the financial markets (typically the banks) faced the heat of rising interest rates due to high inflation. The collapse of banks created panic among developed economies, leading many to compare it with the 2008 financial crisis.
The RBI had to decide on its monetary policy during this sudden shift of sentiments in global financial and oil markets. The RBI Governor in his monetary policy statement echoed similar feelings: “The year 2023 began on a promising note as supply conditions were improving, economic activity remained resilient, financial markets exuded greater optimism, and central banks were steering their economies towards a soft landing. In just a few weeks during March, this narrative has undergone a dramatic shift.”
After delivering these lines, the Governor said that the RBI’s Monetary Policy Committee (MPC) has decided to keep the policy repo rate unchanged at 6.5 percent. The MPC decision was surprising as the market consensus was expecting an increase of 25 bps in the repo rate. The markets expected increase in policy rate as India’s inflation has remained higher than the RBI’s inflation target of 4 percent with a band of +/-2 percent. The graph below shows that both headline and core inflation (which excludes food and fuel items) has been higher than upper band of 6 percent since January 2022.
The markets reacted positively to the RBI pausing as they were expecting increase of policy rates. The yields in bond markets declined tracking the pause with 10-year bond yield declining from 7.27 percent to 7 percent after the policy. The BSE Sensex rose 140 points.
The MPC has projected CPI inflation at 5.2 percent for 2023-24, with Q1 at 5.1 percent, Q2 at 5.4 percent, Q3 at 5.4 percent, and Q4 at 5.2 percent. On the growth front, GDP growth for 2023-24 is projected at 6.5 percent. The growth rates for Q1, Q2, Q3, and Q4 are projected at 7.8 percent, 6.2 percent, 6.1 percent, and 5.9 percent respectively.
Clearly inflation remains higher than the targeted 4 percent for the next year. RBI Governor Shaktikanta Das in the post-policy media conference mentioned that this policy should be seen as a pause not a pivot. He meant that the rate hike cycle has not stopped, and will not pivot to an easing cycle. The RBI and the MPC will take a call based on incoming data. The bank is aware that it is not able to meet its inflation target for a long time now and will want to remain focused on achieving the target.
The inflation will also decline if the monetary transmission improves overtime. The RBI has raised policy rates by 250 bps in the last year, and interest rates on outstanding deposits and outstanding loans has increased by 99 bps and 95 bps respectively. As banks transmit higher policy interest rates on both deposits and loans, there will be higher impact on inflation.
Another concern ahead of the policy was financial stability. Since the 2008 global financial crisis, the central banks have had to balance both price stability and financial stability. Das mentioned that RBI has strengthened its supervisory systems over the years. Unlike developed countries where there are gaps in regulatory systems. The RBI has adopted a unified and harmonised supervisory approach for commercial banks, the NBFCs, and the urban cooperative banks (UCBs).
Having said that, the RBI is watchful of the risks from financial system. Das usually quotes Mahatma Gandhi in his statement. On financial stability he quoted Kautilya: “In the interests of the prosperity of the country, …..[we] should be diligent in foreseeing the possibility of calamities, try to avert them before they arise, overcome those which happen, remove all obstructions to economic activity …..”.
Amen to these thoughts.
(Amol Agrawal is an economist teaching at Ahmedabad University.)
(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.)