Why is the Reserve Bank of India’s MPC likely to execute a hawkish pause this week?

on Oct 4, 2023
  • The RBI is likely to maintain interest rates as is till the end of the year.
  • Inflation has begun to ease in India but remains above the RBI's tolerance band.
  • The Indian rupee is under pressure due to hawkish policy across leading central banks.

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Today, the Reserve Bank of India (RBI) commenced its six-member Monetary Policy Committee meeting (MPC).

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The policy rate decision is to be announced on the 6th of October.

Key concerns for the apex body to consider include domestic consumption, struggling urban unemployment, rural distress, retail inflation, global oil prices, the weakness of the rupee, and the hawkish narrative of leading central banks.

Consumption picture

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In recent months, domestic consumption has witnessed notable strength in urban areas, as well as higher retail lending, record vehicular sales, and robust domestic travel.

In the month of July, retail borrowing increased by nearly 32% YoY and is expected to remain healthy through the end of the year.

Data from the Society of Indian Automobile Manufacturers (SIAM) for August 2023 showed that sales of passenger vehicles reached a new high of nearly 360,000, a 9.4% YoY increase.

September 2023 air travel is projected to come in at approximately 12.3 million passengers, an increase of 7% compared to the previous month.

With the Cricket World Cup hosted by India kicking off tomorrow, and the upcoming festive season, air traffic is expected to soon reach a fresh high while also powering an uptick in consumption demand.

This upswing in consumption has materialised despite a challenging macroeconomic environment, high food inflation amid sky-high vegetable prices, agricultural distress due to sub-optimal weather patterns, tight market liquidity, and higher energy costs.

As per SBI CAPS, private consumption expenditure rose 6% during the quarter, a marked increase from below 3% in the previous interval.

Taxation data also showed that e-way bill collections reached a new all-time high in August 2023, indicating a significant uptick in state-wide and inter-state sales of goods.


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Despite these positive developments, downside risks do exist in the broader economy, with a mixed picture emerging particularly due to persistent rural distress and less-than-optimistic consumer surveys.

In August 2023, The Indian Express reported that the RBI’s current situation index (CSI), a gauge of consumer sentiment declined after nearly two years of a sustained recovery.

The Centre for Monitoring Indian Economy’s (CMIE) Economic Outlook also published in August 2023 noted that consumer sentiments had dipped by 1.5%, particularly in relation to purchasing durable goods.

Still-elevated inflation and poor kharif season sowing due to the extended period of uneven rainfall dented economic activity, leading to an explosion in rural workers seeking employment under the government’s flagship Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) in August 2023.

The latest data reveals that 19.16 million households applied for the scheme during the month, a startling increase of 20% YoY.


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All-India unemployment witnessed an uptick to above 8% in August 2023, with urban areas being especially hard hit at 10.1%.

This was up from 8.1% in the previous month.

In rural areas, high seasonal demand for agricultural labour led to a moderation of rural unemployment to approximately 7% in August 2023, helping to cushion against a patchy sowing season and surging food inflation.

In addition, the central government’s focus on frontloading capital expenditure, which is earmarked to increase by 33% over the previous fiscal is expected to support stronger employment generation, particularly heading into the festive season.

The impact of higher capex was partly reflected in the latest core sector output which showed that cement, electricity, and steel production were up 18.9%, 14.9%, and 1.8%, respectively, during the month of August 2023.


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India, like many other developing nations, has an outsized weightage (well over 40%) attributed to food items within the official measure of retail inflation, the consumer price index (CPI).

Although efforts to improve irrigation, logistics, warehousing, and the functioning of agricultural markets continue to deliver progress, farmers and consumers remain highly susceptible to unforeseen changes in weather patterns, the resultant impact on food prices, and consequently headline inflation.

With chequered rainfall during the monsoon season, vegetable prices went through the roof, increasing by 37.4% YoY and 26.1% YoY in July and August 2023, respectively.

Significantly, headline inflation in July 2023 surged to 7.4%, breaching the RBI’s inflation tolerance band of 4% (+/-) 2%.

Fortunately, the August 2023 data stabilized somewhat, with the CPI moderating to 6.8% amid fresh harvests, as well as targeted measures by the government which included restrictions on cereal exports and the release of additional food stocks.

Yet, price pressures continue to persist, particularly among pulses, which witnessed a decrease of 4.2% in sowing over the previous season, as of the time of writing.

In the August CPI release, food inflation remained elevated at 10.4% YoY but is expected to moderate in the months ahead.

In addition, core inflation has begun to ease, falling below the 5% YoY level in August 2023, while encouragingly the Wholesale Price Index (WPI) has stayed in negative territory.  

Oil prices and their impacts

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A key cause of concern for the RBI is the momentum in global oil prices, which has seen a sustained increase from approximately $60-70 levels earlier this year to above the $90 mark, driven by the voluntary production cuts by OPEC.

As a result, India, which has a high oil import bill could see rising energy costs, as well as a deterioration in the current account deficit which has reached 1.8% of GDP.

However, at the retail level, consumers at the pump may be relatively shielded from more costly energy as oil marketing companies will likely absorb much of the increase.

Due to the hawkish rhetoric of global central banks, elevated import prices, and sharp capital outflows, the USD-INR has remained under pressure and is trading at approximately 83.2 at the time of writing.

To contain the situation and stabilize the rupee, authorities have intervened in the international currency market which has driven forex reserves to a four-month low of $590.7 bn.

Banking liquidity

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Liquidity conditions have remained tight with money market rates shifting towards 7% amid recent quarterly tax transfers to the government.

As of October 2nd, banking liquidity was measured at INR 44.22 bn or approximately USD 530 bn, sharply down from a high of INR 1,485.12 bn or approximately USD 18 bn in September 2023.

This drop came despite the phasing out of the Incremental-Cash Reserve Ratio instituted by the RBI which is slated to end on October 7th, 2023.

While liquidity will likely be cushioned due to fiscal injections from the government in the coming months, moving ahead, monetary policymakers may need to partake in additional liquidity management operations.

Global factors

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Globally, the hawkish narrative among major central banks, such as the Fed and ECB is likely to continue to weigh on emerging markets such as India, weakening domestic currencies and leading to additional portfolio outflows.

On a positive note, Indian government bonds are set to be integrated into JP Morgan’s Global Diversified Index (GBI-EM GD), a benchmark index of emerging markets, from June 2024, which should support rupee demand.

However, partly due to the time to inclusion, as well as the gradual increase of weightage in the index (up to a maximum of 10%), this news has been largely overshadowed by expectations of elevated policy rates in leading advanced economies amid inflationary concerns.

RBI decision

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Given the mix of positive and restraining factors on the economy, and the pressure that the rupee is under, the RBI is likely to execute a hawkish pause and maintain the current policy rate at 6.5%, despite inflation being presently above the tolerance band.

A Bloomberg report published earlier today noted that all economists polled were unanimous in this expectation.

The Committee members are unlikely to deviate from this path until there is sufficient clarity on consumption, employment, inflation, the rural situation, and the economic trajectory in advanced economies.

Although inflation in perishables such as vegetables is likely to continue to moderate, Kaushik Das, chief India economist at Deutsche Bank, noted that the RBI may revise full-year inflation projections slightly upwards from 5.4% to 5.5%-5.7%.

In terms of economic growth, the MPC is widely expected to retain full financial year GDP estimates at 6.5%.

Given the depreciating factors at play for the Indian rupee, the RBI will likely prefer to keep the policy rate elevated for the time being, while liquidity continues to remain on the tighter side.

In all likelihood, without significant shifts in the economic environment, the RBI will maintain the status quo until the end of the calendar year, while keeping a close eye on inflationary factors.

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