https://www.financialexpress.com/opinion/reality-bites-2/4355985
The 25-basis-point (bps) hike in the repo rate, together with the shift in stance from neutral to “calibrated tightening”, gives Wednesday’s policy announcement a distinctly hawkish hue. It is not, however, excessively hawkish. Another 25-50 bps of tightening looks likely, but a longer, steeper cycle seems improbable at this point. A longer cycle would depend on where crude oil prices head, how much of the higher cost is passed on to consumers, the course of US Federal Reserve policy, and where US Treasury yields settle. For now, the move looks more like an insurance policy than the start of an aggressive campaign.
What the change in stance does is give the bond market a heads-up: should the global environment worsen, the central bank may be compelled to tighten further. Without committing itself to the extent or length of the cycle, the Reserve Bank of India (RBI) is making room for future action. As Governor Sanjay Malhotra put it, from here on it is either a hike or a pause; rate cuts are off the table for now. The market got the message, with the yield on the benchmark 10-year bond rising to 7.24%, up 5 bps.
The inflation outlook made a hike necessary now. The RBI expects inflation to average close to 5.8% over the next three quarters, perilously close to the 6% upper end of the tolerance band, and projects it at 5.6% even in Q1FY28. Some of the coming price rise can be put down to base effects, but price increases are becoming more generalised, with core inflation running at 4.2%. The good news is that there is little evidence of supply-side pressures becoming embedded in pricing behaviour, nor, as yet, of demand-side pressures, although the central bank sees the strong growth in money and credit aggregates as a potential risk. Caution is warranted because the economy is growing briskly despite several macro headwinds, with GDP rising 7.8% year-on-year in the June quarter. Having underestimated growth by a wide margin in Q1FY27, the RBI has raised its forecast for the current year by 40 bps to 7.1%. It clearly believes the economy has enough momentum for aggregate demand to withstand costlier money, at least for now. That is a fair assumption, given the buoyancy in several high-frequency indicators, and a 25-bps hike will not raise EMIs by much.
Liquidity is another cushion. The $135 billion of inflows from foreign currency non-resident (bank) deposits should keep the system flush with funds and help temper interest rates, though the governor expects the money to be deployed by March, so the comfort may be temporary. Despite the hike, the rupee fell 35 paise against the dollar on the day. Higher interest rates can help support a currency, but in this case the strength of the dollar, elevated oil prices, and selling by foreign portfolio investors are proving to be the stronger influences. Until oil prices trend decisively lower, the rupee is likely to remain under pressure. A weaker currency also adds to imported inflation, which is one more reason for the central bank to keep its options open. It is just as well that the RBI has enough foreign exchange reserves to moderate the pace of depreciation. In sum, the policy buys the RBI time and flexibility; how much more it needs to do will be decided as much by global oil and bond markets as by domestic conditions
