One more hike, then pause

That said, the current tightening cycle is likely to peak with the April hike. And, with heightened uncertainty and many moving parts, rate decisions will not come easy. In an interconnected world, India’s monetary policy is influenced by both local macroeconomic developments and global monetary policy direction, with the former playing a dominant role. A complex interplay of growth, inflation and heightened financial sector risks after the collapse of Silicon Valley Bank are shaping monetary policy directions of systemically important banks like the US Federal Reserve (FED) and the European Central Bank (ECB).

Since RBI’s February policy announcement, global growth has held up well with S&P Global recently raising its world gross domestic product forecast for 2023 to 2.7% from the 2.3% estimated earlier. This is due to better than expected first-quarter performance of Europe and the US, and upgrading of China’s growth to 5.5% from 4.8%. That said, the US and Europe are expected to face a shallow recession with 2023 GDP growth at an anaemic 0.7% and 0.3%, respectively, as rate hikes and tightener financial conditions bite in the remaining part of the year.

Inflation, (especially core), in advanced countries has proved to be stubborn, and likely to stay sticky. This implies central banks will have to continue raising rates to control inflation.

Banking sector stress and ensuing financial stability risks, however, have made the situation complex and monetary policy decision-making extremely complicated. It is leading to a faster tightening of financial conditions, and doing some of the US Fed’s job of slowing the economy to tame inflation. We expect the Fed’s policy rate to peak with another rate hike of 5.0-5.25 with rate cuts only in 2024. The ECB is expected to follow a similar path. The markets are, however, pricing in quicker rate cuts from the Fed.

Net-net, the developments created expectation of less monetary policy aggression from systemically important central banks and reduced external pressure on emerging market central banks. Although the rate hike cycle in emerging markets is nearing its end, domestic conditions will determine how quickly it will happen across countries. India’s inflation has remained above RBI’s comfort zone. In the past 12 months, consumer inflation has hovered below Mint Road’s upper tolerance limit of 6% only on two occasions, and printed 6.4% in February. We do expect inflation to come down to 5% in fiscal 2024 in our base case from around 6.8% in FY23, but the risks to this forecast are tilted upwards. Core inflation has stuck around 6% and may not come down significantly as there is pressure on companies to pass on the incremental input costs to consumers. Assuming crude prices at around $85 per barrel, we see fuel inflation softening from a high base of about 10% in fiscal 2023.

The biggest risk to food inflation, which has a 40% weight in consumer price index (CPI), is from increased frequency and intensity of freak weather incidents. The weather events of March have caused some damage to cereals, fruits and vegetables. The risk of EL Nino, invariably associated with scanty rains, is a big concern for this year’s agriculture output. Fingers crossed on that. Although we project GDP growth to slow to 6% in fiscal 2023, the upside risks to inflation are elevated at this juncture. RBI, therefore, is likely to go for a rate hike on 6 April before hitting the pause button.

Dharmakirti Joshi is chief economist, Crisil Ltd.