RBI may conclude FY23 with a 25 bps rate hike to tame India’s sticky core inflation

The Reserve Bank of India’s rate-setting panel is expected to opt for a smaller rate increase of 25 basis points (bps) in its last policy review of the ongoing fiscal (FY23). RBI’s Monetary Policy Committee (MPC) may also shift to a neutral stance while focusing on growth this time around.

The decision of RBI Governor Shaktikanta Das-headed six-member MPC will be announced on Wednesday at 10 am.

The prediction of a smaller rate hike can be attributed to softening of retail inflation and the US Federal Reserve moderating the pace of increase in its benchmark interest rate.

In its December monetary policy review, the central bank had raised the benchmark interest rate by 35 bps after delivering three back-to-back 50 bps hikes.

External headwinds
The supply-chain disruptions caused by geopolitical tensions between Russia-Ukraine can be linked with hardening of prices. This, in turn, is fueling inflation globally.

Commodity prices have shot up globally owing to supply constraints caused by the war. In order to curb the ‘imported’ inflation, the RBI has been increasing the short-term lending rate aggressively.

"Our inflation remains elevated, but there has been a welcome softening in November and December. Core inflation, however, remains sticky and elevated," Governor Das had said.

Fed check
Since May 2022, the RBI has raised rates by 225 bps.

The Federal Reserve had raised rates by 25 bps last week, following a half-point increase in December and four jumbo-sized 75 basis-point hikes prior to that. The Fed has increased policy rates by 450 bps since May.

After starting 2022 with a near zero rate, the US Fed has now raised the target range for the federal funds rate to 4.5 per cent-4.75 per cent. The funds rate was at 3.75 per cent-to-4 per cent before RBI’s December review.

Shift to neutral stance likely
An overwhelming majority of participants in an ET Poll expect the RBI to raise the key policy rate by a quarter percentage point this week due to stubborn core inflation, potentially signaling the peak in the current cycle of rate hardening. Many also expect MPC to change its policy stance to neutral from accommodative, with the real rates having turned positive.

While talking about the rate hike, Apurva Sheth, Head of Market Perspectives & Research, SAMCO Securities, said, “We believe that the RBI will hike rates by another 25 bps in the February meeting. This will push the rates to a seven year high of 6.5 per cent. RBI will go with a wait and watch approach after this meeting and slowly shift focus on growth.”

Amid projections of slower growth than previously forecasted for 2023-24, the RBI will probably stick to a moderate increase in its benchmark lending rate in the upcoming policy announcement, before hitting a pause button on hikes later in 2023, said Dhruv Agarwala, Group CEO, Housing.com.

“Considering the trend of CPI the RBI may go in for a smaller increase in repo rate by 25 basis points. However, with the sticky core inflation and the persisting rate increase by the US Fed, the RBI may continue with a cautious approach to tame inflation while supporting growth over the long term. The stance may be shifted to neutral while keeping a close watch on liquidity,” said Jyoti Prakash Gadia, MD, Resurgent India.

Recently, RBI Governor Das had said that with some ebbing of Covid-related restrictions and cooling of inflation in various countries, though still elevated, central banks have started what appears to be a pivot towards lower rate hikes or pauses.

"At the same time, they continue to emphatically reiterate their resolve to bring inflation down closer to targets. High policy rates for a longer duration appear to be a distinct possibility, going forward. On the growth front, projections are now veering around to a softer recession as against a severe and more widespread recession projected a few months back," he had said.

The RBI has been tasked to ensure that retail inflation remains at 4 per cent with a margin of 2 per cent. However, it failed to keep the inflation rate below six per cent for three consecutive quarters beginning January 2022.

However, since the past few months the retail inflation based on the Consumer Price Index (CPI) has shown signs of moderation in November and December as it fell below the RBI's upper tolerance level of 6 per cent.