On Friday, the monetary policy committee of the Reserve Bank of India voted unanimously to raise the benchmark policy repo rate by 50 basis points. With the latest hike, the MPC has now tightened the policy rate by 140 basis points over the course of its last three meetings. The repo rate now stands at 5.4 per cent, marginally above the pre-pandemic level of 5.15 per cent in February 2020. The tone of the policy was in line with expectations with the committee emphasising the need for “calibrated monetary policy action” to contain inflationary pressures and bring headline inflation “closer to the target”.
The central bank’s commentary on both growth and inflation remained unchanged. On inflation, even though the consumer price index (CPI) in the first quarter of the year came in marginally lower than the RBI’s earlier projection, the central bank has broadly retained its earlier forecast for the full year, though with minor tinkering in the quarterly estimates. The inflation projection for the full year stands at 6.7 per cent. However, price pressures are likely to subside sharply in the second half of the year. After averaging 7.1 per cent in the second quarter, the RBI expects CPI to trend lower to 6.4 per cent in the third quarter, and 5.8 per cent in the fourth quarter, though there remains uncertainty over services inflation and how the rains will play out. Alongside, the RBI has also retained its growth forecast at 7.2 per cent for the ongoing financial year. While, going by the forecasts, growth is expected to slow down sharply in the second half of the year, the governor noted that “domestic economic activity is exhibiting signs of broadening”. As per the RBI’s surveys, capacity utilisation in manufacturing was higher than its long-term average, which, as the governor noted, signals the “need for fresh investment activity”.
With even the latest forecasts suggesting that prices will remain well above the central bank’s inflation target, the MPC should continue to focus squarely on inflation management, though the normalisation of policy suggests that the pace of tightening may moderate over the course of the next meetings. While the committee has not clearly elaborated on the extent of tightening it envisages as it seeks to bring inflation in line with the target, the commentary on the natural interest rate does provide some guidance. In the RBI’s June bulletin, economists at the central bank had estimated the natural rate for the post-pandemic period to be in the range of 0.8-1 per cent, which was 80 basis points lower than the earlier comparable estimate. Considering that the central bank has now projected inflation at 5 per cent in the first quarter of the next financial year, this does provide some sense of the likely path of the policy rate.