Mumbai: Executives at the Reserve Bank of India (RBI) have rarely been this comfortable when developed nations’ financial markets were in turmoil. Soaring yields, rising defaults, wobbly financial markets and troubled geopolitics are all around, but few ripples are seen here.
When the Federal Reserve chairman and the European Central Bank president are still guiding for raising interest rates, RBI Governor Shaktikanta Das, when he reveals the status quo monetary policy on Thursday, can step aside while providing the central bank’s customary cautionary footnote on remaining vigilant.
At the heart of monetary policy making is prices and the character of that is diverging between developed markets and the emerging markets, especially India, which tracks a consumer price index loaded with food articles.
Prices are set to rise more than the target for some more quarters, but the solace is that the RBI’s target of 4% is less than 200 basis points away. The end goal is double that for the likes of the US, which has a 2% mandate.
The flexible inflation targeting framework, born out of the crisis due to soaring inflation and ‘taper-tantrum’ in 2013, gives the RBI a further 2 percentage point buffer at a tolerable 6% upper band. Taper tantrum refers to Federal Reserve Chairman Ben Bernanke’s first signal to suck out liquidity that caused upheaval in the financial markets.
The crisis in India was attributed to persistently high inflation and negative real interest rates that led to investors choosing real estate and gold over financial securities, depressing financial assets. The solution then was to ensure positive real interest rates, where risk-free return is higher than the rate of inflation.
One question that both Governor Das and his deputy Michael Patra would avoid giving a straight answer to is what would be the real interest rate that would comfort them. And there lies the answer as to how the Monetary Policy Committee (MPC) would approach the problem. An MPC member gives a peek into the thoughts.
“Headline inflation forecasts have risen in the short-term but remain slightly above 5% for the next year so that a repo rate of 6.5% still gives a positive real rate of around unity,” said Ashima Goyal, external member of the MPC. “This is the apt real rate given the uncertainties in both growth and inflation.”
Given that monetary policy actions impact with a lag, the series of hikes since 2022 across the globe is beginning to pinch. Price pressures could ease, although the pace may differ across geographies.
The Indian CPI is loaded with farm products and can swing to extremes. The cost of a vegetarian meal plate fell 17% on-month in September with significant contribution from tomatoes which declined 62%, said Crisil. Inflation in August fell to 6.8%, down from 7.4% in July.
Furthermore, there are enough tools in the form of tax rates, price and trade controls to prevent runaway prices.
The RBI may raise its inflation forecast to as high as 5.7% from 5.4% now. But its medium-term forecast for April-June 2024 could be at 5.2% average and January-March 2025 at 4.4%, which is key to policy decision-making, says Deutsche Bank.
The rate-setting committee goes by inflation forecast than by past numbers. Even if it bumps up its next fiscal-end forecast by 100 basis points in an extreme case to 5.4%, it would still have room to maintain the status quo for a long time with repo rate at 6.5%.
“While there hasn’t been an explicit mention of the real rate buffer, prior indications have been that about 100-125 basis points could be considered appropriate,” said Radhika Rao, economist at DBS. “Inflation is on course to return to the 2-6% target range in September, along with a steady core but policymakers will continue to take a forward-looking view.”
High global yields and financial stability could keep the central bank on high alert, but positive real rates gives it a long rope to be on pause.
