The Reserve Bank of India’s (RBI’s) rate-setting panel will likely continue with its accommodative stance and hold interest rates despite geopolitical risks in the wake of the Russia-Ukraine conflict as it continues to take a dovish view on inflation.
Economists said RBI is widely expected to begin tightening monetary policy only later this year, and the altered geopolitical situation since the last meeting of the monetary policy committee (MPC) in early February would not lead to any immediate rate changes. Russia’s attack on Ukraine last week threw global and domestic markets into turmoil and led to Brent crude hitting $100 per barrel, stoking inflation fears.
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In a surprise move, the monetary policy panel kept policy rates unchanged in its February meeting even as global central banks raised rates to counter post-pandemic inflation. The divergence with other central banks on rates stems from RBI’s belief that the character of India’s inflation is a bit different from other economies. However, RBI governor Shaktikanta Das said in the MPC meeting that since inflation is expected to cool over the next financial year, there will be room for monetary policy to remain accommodative.
“We reiterate that such dovish messaging on inflation makes it difficult to envisage the RBI hiking rates in the near term," economists at Barclays wrote in a note to clients on 24 February.
Barclays said RBI would likely prefer only a gradual path of policy normalization. “While RBI may choose to normalize the policy corridor over the next six months, we expect repo rate hikes to only begin from Q3 2022—the August meeting—with risks of further delays," Barclays said.
According to economists at Emkay Global Financial Services Ltd, policymakers may not react immediately through the interest rate channel. The stout policy signalling in the MPC meeting and generally dovish minutes imply RBI would go slow on policy transition, it said. “We maintain our view that RBI has some policy flexibility on hand, which will delay repo rate hikes," Emkay said.
For some time now, RBI has posited that supply-side constraints are driving domestic inflation, and when bottlenecks ease, the inflation trajectory will moderate. In the February meeting, Das pointed out once again that inflation pressures in India continue to emanate largely from supply-side factors. Supporting this view, deputy governor Michael Patra said the pandemic inflation surge is driven not by excess demand but by supply constraints.
Others believe it is time for the central bank to act, considering the change in the situation in the last 15 days. Also, considering India meets 85% of its oil demand through imports, a rise in crude oil prices will feed into inflation.
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“Given the fact there are conditions which have changed in the last 15 days, there is a strong case for RBI to relook at the assumptions made at that particular point in time. It was assumed that while oil prices would be an issue, it was not taken too seriously then, and that consideration has changed owing to the recent geopolitical tensions and crude hitting $100/barrel," said Madan Sabnavis, chief economist, Bank of Baroda.
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