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Why Did the RBI Pause its Rate Hikes? Examining the Factors behind the Decision

Here, we will discuss the recent developments in the Monetary Policy Committee (MPC) meetings. In the last two meetings, the MPC surprised many by deciding to pause its rate hikes, contrary to market expectations.

The main reason behind the MPC's decision to pause the rate hike seems to be the inflation projections. Although India's real GDP growth for FY24 is now pegged at 6.5 percent, compared to 6.4 percent at the MPC’s February 2023 meet, the inflation projections for Q1 are slightly higher than anticipated, at 5.1 percent. However, inflation projections for Q4 have been lowered to 5.2 percent, thanks to the base effect.

The RBI governor has also spoken about the heightened uncertainty in the current economic environment, making it difficult to predict inflation rates accurately. It's worth noting that a year ago, the RBI projected inflation at 5.1 percent in Q4 FY23, but the reality is that inflation is now above 6 percent, beyond the RBI’s upper limit. Hence, the MPC may be cautious about making predictions about inflation rates.

There is also a belief that the real policy rate is now high enough to warrant a pause. Still, this is likely only because inflation surprised to the upside in Q4 FY23. To be sure, inflation is likely to be lower than 6 percent from March 2023 onwards because of the base effect. However, the RBI governor has talked a lot about core inflation being elevated, indicating the need for caution.

The governor quoted Kautilya as saying, “Be not slack before the whole job is finished,” suggesting that the RBI still has work to do in containing inflation. However, the Monetary Policy Review says that even in Q4 of FY25, retail inflation will be at 4.4 percent. Is bringing inflation down to 4 percent completely open-ended then, to be done at some unspecified point in future?

Although the RBI governor has spoken about the decision to keep rates unchanged being a one-off, it's unclear whether the MPC will raise rates later this year when the base effect ensures that headline inflation comes down.

Many economists have penciled in much lower growth for India than the RBI forecasts, citing the slowdown in global growth and the banking crises in the US and Europe. Slower global growth would lower inflation, particularly for commodity-importing countries such as India.

In conclusion, while the MPC's decision to pause the rate hike may be based on a complex set of factors, including inflation projections, global growth concerns, and uncertainty, it remains to be seen whether this decision will pay off in the long run. We will continue to monitor the situation and bring you the latest updates.

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