RBI Increases Interest Rates: What Does It Mean for India's Economy?

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has increased the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.50% with immediate effect.

This decision was taken during the MPC meeting held on 8th February 2023. The standing deposit facility (SDF) rate has been adjusted to 6.25% and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.

RBI Policy: Domestic Economic Outlook

The first advance estimates (FAE) placed India's real GDP growth at 7.0% YoY for 2022-23, driven by private consumption and investment. High-frequency indicators suggest that economic activity has remained strong in Q3 and Q4 of 2022-23.

The overall demand has been sustained by strong discretionary spending, with urban demand exhibiting resilience, and rural demand improving. Investment activity is gradually gaining ground.

Inflation moderated to 5.7% YoY in December 2022 due to double-digit deflation in vegetable prices, while inflationary pressures increased in cereals, protein-based food items, and spices. Fuel inflation rose primarily due to an increase in kerosene prices. Core CPI (excluding food and fuel) inflation rose to 6.1% in December due to sustained price pressures in health, education, and personal care.

The overall liquidity remains in surplus, with average daily absorption under the LAF increasing to INR 1.6 lakh crore during December-January. Money supply (M3) expanded by 9.8% YoY as on 27th January 2023, while non-food bank credit rose by 16.7%. India's foreign exchange reserves were placed at $576.8 billion as on 27th January 2023.

Monetary Policy Statement by Shri Shaktikanta Das, RBI Governor - February 08, 2023 https://t.co/KGPgzXbpWN

— ReserveBankOfIndia (@RBI) February 8, 2023

RBI Policy 2022-23: Global Economic Outlook

The global economy has shown improvement despite the persistence of geopolitical conflicts and the impact of monetary policy tightening by central banks around the world.

Although growth is expected to decelerate in 2023, the inflation is showing some softening from elevated levels, leading central banks to reduce the size and pace of rate actions.

Despite these developments, central banks are reiterating their commitment to reducing inflation close to their targets. The US dollar has come off its recent peak, and equity markets have moved higher since the last MPC meeting.

However, weak external demand in major advanced economies, rising protectionist policies, volatile capital flows, and debt distress may weigh negatively on the prospects for emerging market economies.

Inflation Projections

The outlook for inflation is mixed, with the improvement in prospects for the rabi crop, especially for wheat and oilseeds, tempered by risks from adverse weather events. The global commodity price outlook, including crude oil, is uncertain due to both demand prospects and supply disruptions due to geopolitical tensions.

Commodity prices are expected to face upward pressures as mobility restrictions ease in some parts of the world. The ongoing pass-through of input costs to output prices, especially in services, could continue to exert pressures on core inflation.

Taking into account these factors and assuming an average crude oil price (Indian basket) of $95 per barrel, inflation is projected at 6.5% in 2022-23, with Q4 at 5.7%. On the assumption of a normal monsoon, CPI inflation is projected at 5.3% for 2023-24, with Q1:2023-24 at 5.0%. The inflation projections are subject to the risks mentioned above and will be closely monitored.

The RBI's decision to increase the interest rate is aimed at ensuring that inflation remains within the target while supporting growth.