Where exactly will the RBI rate policy go from here?

When the RBI announced its monetary policy this week, there was not much of a surprise element. The 25 bps rate hike was factored in. The big question now is where does RBI policy go from here?

Rate hike trajectory

Is the RBI done with rate hikes and is it close to its terminal rate target. While it is hard to say if the RBI is done with the rate hikes, it is clear that we may be bit too close to the eventual terminal rate target. Whether that target is 6.75% or 7.00% is something we have to wait and see, but clearly the 250 bps rate hike between May 2022 and February 2023, is a signal that we may be close to the peak rates. How will the RBI go about handling rates from here on.

It would depend on inflation

The neutral rates in India are around 5% and currently the rates are well above the neutral rates. That is a level where additional rate hikes have a direct impact on the GDP growth rates. It is a piece of good fortune for the Indian economy that growth has not seen any negative impact. Even the first advance estimate of FY23 GDP has pegged the full year GDP at 7.0% and that is the target that even the RBI has set as its GDP growth target for FY23. The joker in the pack would be inflation as any decision to conclude the rate hike plan would largely predicate on how much the consumer inflation is well in control.

What about rate cuts?

It would be a decision that the RBI will prefer to synchronize with other central banks. The risks of diverging could be quite high. However, it is very likely that India could be the first off the block when it comes to turning the interest rate cycle. One can safely assume peak rate cycle of 7%, but is very unlikely to go much beyond that. However, India may be first off the block when it comes to rate cuts. India has been identified as the fastest growing large economy by the IMF and also the World Bank. It would be keen to retain its growth edge over China and that means, India can’t afford to have too much hawkishness in the way of its growth plans on GDP.

Expect a major fiscal shift too

One thing we could see in the coming weeks and months is the gradual shift of the Indian policy thrust from monetary to fiscal policy. If one looks at the latest Union Budget, there are a number of fiscal measures. India plans to cut its fiscal deficit in an aggressive way, to give a big boost to capital spending by 33% in FY24 and also cut down sharply on its subsidy bill. Clearly, the message is that India is not going to rely on monetary levers to manage the bounce in macro growth. It would facilitate the revival in growth through fiscal policy. RBI may be close to the rate peak. However, it would be expected to play a smaller role in the growth grand plan! 

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