Why did RBI leave key rates unchanged?

The Reserve Bank of India (RBI), as expected, on June 7 kept the key lending rate unchanged at 6.5 percent. That rate action — or no action — is in line with what the majority of economists and bankers said in a Moneycontrol poll.

The Mint Street’s messaging is clear —  fighting inflation is and will remain the focus of RBI governor Shaktikanta Das and his monetary policy committee (MPC) colleagues. There is no going back till inflation falls to the medium-term target of four percent.

If projections are anything to go by, it is unlikely to happen anytime soon.

After Das’ announcement, equity benchmarks the Sensex and the Nifty were trading up, as investors cheered the central bank’s continuous focus on inflation. Bond yields and the rupee were largely stable.

For Das and his MPC colleagues, nothing much has changed on the inflation front since the previous policy review in April. For sure, inflation has been easing below 5 percent but that is not enough. Inflation is above where the central bank wants it to be.

In April, India’s retail inflation came in at 4.83 percent against a 10-month low of 4.85 percent in March.

Sharp focus on inflation

The central bank has on several occasions said that after bringing inflation within the 2-6 percent target ban, the next aim is to align with the 4 percent target, that, too, on a sustainable basis, which means prices have to remain low continuously for at least a few quarters.

According to RBI’s estimates, inflation is expected to remain above 4 percent throughout this fiscal except a likely blip — 3.8 percent — in the second quarter. The RBI has retained the FY 25 inflation forecast at 4.5 percent, assuming a normal monsoon.

The CPI inflation for the first quarter is projected at 4.9 percent, second at 3.8 percent, third at 4.6 percent and fourth at 4.5 percent.

Food prices 

“Uncertainties related to food prices warrant a closer monitoring,” Das said, adding the RBI wanted to see an inflation decline to 4 percent sustainably.

Separately, the RBI raised the full-year growth target to 7.2 percent from 7 percent. This means there is no immediate urgency on the part of the central bank to cut rates to support growth, which is doing well. Das said higher growth gives the central bank the elbowroom to act on inflation.

Now, the critical question — what next? When can we expect the first rate cut? For answers, let us look at the following factors:

One, how will the monsoons behave?

The India Meteorological Department (IMD) has forecast an above-normal monsoon. There, however, are two significant fresh upside risks to these assumptions now — a possible surge in global crude prices if the Iran-Israel conflict escalates and a potential food inflation spike from the impact of heatwaves in the next two months. There are no answers at this point.

Two, how will the surprise poll verdict impact the fiscal consolidation roadmap?

Till the counting day, most pollsters predicted a clean sweep for the BJP. The final verdict found the party falling way short of the majority mark of 272, with the Congress-led INDIA bloc managing 234 seats.

With the BJP heavily reliant on two powerful regional allies — the Telugu Desam Party and Janata Dal (United) — to form the government, there is talk of “coalition compulsions”. If the government switches gears to a populist mode, focusing on welfare measures due to the pressure from allies, this could have ripple effects on inflation management.

In such a scenario, the RBI may have to stay in the hold mode longer.

Three, how will food prices and a lower base effect play out?

Rating agency ICRA said the food and beverages inflation will retrace above the 8 percent mark in May, partly on account of the adverse base as well as the above-normal temperatures and heatwave conditions, which would push up the headline CPI inflation to a five-month high of 5.1-5.2 percent.

Four, the impact of global factors

A surge in global crude oil prices in the event of an escalation in the Israel-Iran conflict, coupled with the impact of a possible heat wave across India, which may trigger a spike in food inflation, could upset the inflation calculation of the rate-setting panel.

Tackling inflation is the key

The central bank doesn’t want to rush into rate reversal and concede the hard-won gains till it sees clear signs of inflation easing to 4 percent, till that time, it’s a clear hold.

How long the status quo lasts will depend on the inflation trajectory and the many factors in play.

“On inflation, we are on the right track but still there is work to be done,” Das said.

The Mint Street deserves applause for its sharp focus on bringing down inflation.

High inflation, along with rising unemployment, is a big worry, as it takes away purchasing power as prices of essential items rise sharply while the income levels grow at a slower pace.

This effectively denies aam aadmi the fruits of higher growth and this is a problem that Asia’s third-largest economy needs to tackle at any cost.

(This article first appeared on Moneycontrol on June 7)