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In monetary policy beginning tomorrow, RBI is expected to keep the policy rate at 6.5% while attempting to keep liquidity tight.
What factors RBI is taking into consideration?
Inflation rate
Domestic inflation rose to 7.4% in July before falling down to 6.8% in August and likely approaching 5.5% by December. However, it is still substantially above the 4% target and is expected to remain so for at least a few more quarters. Though there is a downward trend in inflation, it remains over the RBI’s target.
With inflation targeting, a central bank establishes a specific objective for the rate of inflation and modifies its policy instruments, such as interest rates, to meet that aim.
The Reserve Bank of India (RBI) has a tolerance range of +/- 2% and a 4% inflation target. This indicates that while the RBI prefers to keep inflation at 4%, it will tolerate it between 2% and 6%.
So, in order to remain within the target range, RBI is aiming to tighten up the liquidity.
GDP outlook
The GDP fundamentals remain good, but the primary question is the impact of a weak monsoon on agricultural production, according to the BoB study. It anticipates GDP growth of roughly 6.3 percent in FY2024, slightly lower than the RBI’s forecast of 6.5 percent.
With the current economic headwinds, RBI is expected to maintain its FY24 growth projections at 6.5 percent, as the RBI will likely adopt a ‘wait and watch’ approach, looking for greater clarity on festive demand trends and kharif production estimates before making any adjustments, according to Care Ratings.
Crude oil prices
International crude oil prices have averaged roughly $89 per barrel since the August 10 policy, well above the $85 per barrel considered in RBI predictions (April 2023 policy briefing). In fact, prices have been lingering above $90 per barrel since September 8. According to a recent Bank of Baroda analysis, oil prices averaged around $79 per barrel at the time of the previous RBI policy, meaning a 12.6% increase in prices since the previous policy.
Rising crude prices benefit oil exporters while harming oil-importing countries like India. Every ten-dollar increase in Brent crude prices increases India’s current account deficit by 0.5%. As a result, the INR depreciates, leading to imported inflation, according to Dr. V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.
As a result, when inflation rises, the RBI may raise interest rates or retain the policy rate while taking other economic factors into account in order to keep inflation under control.
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