The current environment of stubborn inflation with rising inflationary expectations, moderating growth, high cost of funds & delay in capex cycle complicates RBI’s policy decisions. The Global and domestic financial market conditions are also very divergent. While the former have historic low interest rates and ample liquidity, the latter is grappling with tight liquidity and high rates. RBI has already rendered an effective tightening of 300bps last year, taking policy rates to normalized levels & making RBI one of the most aggressive Central Banks amongst the EMs.
However, the rising pressure & political will to tame inflation which has remained above RBI’s comfort zone for over a year now may translate into a 25bps hike in repo rate in the ensuing policy, prioritizing inflation over growth. In my view, any excessive tightening may risk derailing the investment cycle which is necessary not only to sustain growth, but also to tame structural inflation. The RBI may tolerate little higher inflation for a while as monetary tightening can play only a limited role in easing supply-side inflationary pressures.
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