Explained: Why RBI kept interest rate unchanged for second time in a row

Mumbai: The Reserve Bank of India on Thursday left its key interest rate unchanged for a second straight policy meeting but signalled that it wants to see inflation moderate more while keeping an eye on the monsoon.

The monetary policy committee (MPC), which has three members from the RBI and an equal number of external experts, voted unanimously to keep the benchmark repurchase or repo rate unchanged at 6.50 per cent.

It decided 5:1 to retain the policy stance focused on "withdrawal of accommodation", which was introduced in April last year.

While consumer price inflation eased during March-April 2023 and moved into the tolerance band, headline inflation is still above the target of 4 per cent and is expected to remain so during the rest of the current fiscal, RBI Governor Shaktikanta Das said announcing the monetary policy decision.

"Therefore, close and continued vigil on the evolving inflation outlook is absolutely necessary, especially as the monsoon outlook and the impact of El Nino remain uncertain," he said. "Our goal is to achieve the inflation target of 4 per cent and keeping inflation within the comfort band of 2-6 per cent is not enough." The central bank kept its GDP growth projections for the current fiscal (April 2023 to March 2024) unchanged at 6.5 per cent while marginally lowering the retail inflation expectation to 5.1 per cent from the previous 5.2 per cent.

India grew by 7.2 per cent in the previous fiscal, making it one of the fastest-growing nations in the world.

The fuller impact of a cumulative 250 basis point increase in repo rate prior to the pause since April, will be evident in the coming months, Das said.

The RBI has now moved its priority to growth with stability.

While most global central banks have paused on rate hikes as commodity prices ease, Australia and Canada have surprised markets this week by resuming rate hikes to combat stubbornly high inflation.

The decision to keep the stance as withdrawal of accommodation was driven by liquidity conditions easing with daily system liquidity averaging at Rs 2.3 lakh crore in June. The improvement in liquidity was due to a significant rise in government expenditure and a decline in currency in circulation.

Later addressing a news conference, Das said the stance unchanged "is not a pivot but only a pause" and that future policy actions will purely be data-dependent as a durable fall in inflation is still a long way.

"It is not a pivot; I reiterate this is only a pause, which is the second one in two successive reviews. Our future policy actions will purely be dependent on evolving situations. Because even though the recent fall in headline inflation to within the target band (led mainly by the cooling core inflation), we need to ensure that it is durable, and therefore there is no room for complacency on inflation," he said.

The RBI reiterated its "watchful stance" to emerging risks and a commitment to maintain price stability and provide ample liquidity for economic growth.

Most analysts believe rates are likely to be on pause for a long unless there is any dramatic shift in inflation, growth or global volatility.

Rumki Majumdar, an economist at Deloitte India, said the pause is "a judicious move in the current economic climate and a clear signal of their steadfast focus on inflation control while simultaneously balancing the need for economic recovery".

"The maintained repo rate will provide some relief to industries and MSMEs as these sectors are still recovering from the impact of the pandemic and any increase in borrowing costs could hinder the recovery. It may also be aimed at mitigating financial stress in rural areas and supporting rural demand," Majumdar said.

Virat Diwanji, Group President and Head – Consumer Bank, Kotak Mahindra Bank, said the trend is expected to continue unless potential threats like sub-par monsoon and a spike in crude prices swing the headline inflation beyond the RBI's comfort zone.

The policy repo rate has been increased by 250 basis points since May 2022 and is still working its way through the system, Das said.

"The MPC will continue to remain vigilant on the evolving inflation and growth outlook. It will take further monetary actions promptly and appropriately as required to keep inflation expectations firmly anchored and bring down inflation to the target," he said.

On growth, Das said higher rabi crop production, expected normal monsoon, continued buoyancy in services and softening inflation should support household consumption. On the other hand, given the healthy twin balance sheets of banks and corporates, supply chain normalisation and declining uncertainty, conditions are favourable for the capex cycle to gain momentum.

Robust government capital expenditure is also expected to nurture investment and manufacturing activity.

The RBI governor said India's trade deficit has narrowed on the back of a sharper decline in imports vis-a-vis exports.

"We have made good progress in containing inflation, supporting growth and maintaining financial and external sector stability," he said. "Despite three years of global turmoil, India's growth has bounced back and headline CPI inflation is easing." Stating that inflation needs to be brought down below 4 per cent, he said it is always the last leg of the journey which is the toughest.

"I wish to emphasise that we will do whatever is necessary to ensure that long-term inflation expectations remain firmly anchored," he said. "The Reserve Bank will remain watchful and proactive in dealing with emerging risks to price and financial stability."

Other measures announced on Thursday included allowing scheduled commercial banks to set their limits for borrowing in Call and Notice Money Market, giving two more years to primary urban cooperative banks to achieve priority sector lending (PSL) targets, expanding the scope of e-RUPI digital vouchers issued by banks, and permit issuance of RuPay prepaid forex cards by banks.