RBI Raises Inflation Forecast to 5.4% Citing Food Prices, Keeps Interest Rates Unchanged

Mumbai: The Reserve Bank of India (RBI) on Thursday left its key interest rates unchanged for a third straight meeting but signalled tighter policy if food prices drive inflation higher.

The monetary policy committee, which has three members from the central bank and a similar number of external members, held the benchmark repurchase rate (repo) at 6.50% in a unanimous decision.

The RBI raised its inflation forecast for the current financial year ending March 2024 to 5.4% from 5.1%, citing pressures from food prices. In the July-September quarter, it saw inflation at 6.2%, significantly higher than the 5.2% earlier forecast.

"We do look through idiosyncratic shocks but if it shows signs of persistence, we have to act," he said detailing decision of the MPC meeting here. 

It retained the stance on "withdrawal of accommodation" but Governor Shaktikanta Das sounded hawkish when he highlighted that headline inflation needs to subside sustainably below 4% and any surge in the inflation print, if continued for a longer period, may necessitate fresh action.

The hawkish stance was also reinforced by the unexpected announcement of reducing the cash in the banking system by raising the incremental cash reserve ratio (ICRR) to 10% on the incremental NDTL (net demand and time liabilities) over the last three months. This will help in absorbing a large part of the excess liquidity created through the return of the Rs 2,000 notes and the large dividend to the government from RBI.

The move is expected to suck out about Rs 1 lakh crore from the banking system, he said, adding that this liquidity tightening measure will not impact credit needs of productive sectors.

"The job on inflation is still not done," Das said. "Inflationary risks persist amidst volatile international food and energy prices, lingering geopolitical tensions and weather-related uncertainties."

The MPC drew confidence from moderation in core prints and expects a seasonal correction in food prices in the fourth quarter of 2023.

This is the third straight meeting where RBI kept interest rates unchanged. Prior to that, it had raised interest rates by 250 basis points (bps) since May 2022 in a bid to cool surging prices.

RBI retained its projection for Indian economic growth at 6.5% for the current 2023-24 fiscal year (April 2023 to March 2024)."Aggregate demand conditions continue to be buoyant," Das said. Food price spikes in India, typical at the onset of the monsoon, drove up headline inflation in June, snapping a four-month downward trend.

Headline inflation, after reaching a low of 4.3% in May 2023, rose in June and is expected to surge during July-August led by vegetable prices.

"While the vegetable price shock may reverse quickly, possible El Niño weather conditions along with global food prices need to be watched closely against the backdrop of a skewed south-west monsoon so far," Das said. "These developments warrant a heightened vigil on the evolving inflation trajectory."

The MPC, he said, "remains resolute in its commitment to aligning inflation to the 4% target and anchoring inflation expectations".

"Bringing headline inflation within the tolerance band is not enough; we need to remain firmly focused on aligning inflation to the target of 4.0%," he said.

Other measures announced on Thursday included a proposal to put in place a transparent framework for reset of interest rates on floating-interest loans. It will also provide borrowers options for switching to fixed-rate loans or foreclosure of loans.

RBI also allowed 'conversational payments' on UPI, which will enable users to engage in conversation with AI-powered systems to make payments.