RBI finally gets uppity, takes a hike

RBI joined the global concert of central banks on Wednesday, raising interest rates by 25 basis points to 5.5% to hold down inflation driven by the Iran energy crisis. India stands out among the major economies entering an interest-rate upcycle for a couple of reasons. One, the economy is expected to grow robustly despite its vulnerability to an imported energy shock. Two, transmission of international energy prices to consumers is incomplete. These will influence RBI's hawkishness over this cycle, despite its low tolerance for growth sacrifice in fighting inflation. The central bank has changed its policy stance from neutral to calibrated tightening, which Sanjay Malhotra explained avoids pre-committing to a series of hikes. The data-driven approach could, however, result in inflexibility if the data turns out to be, well, adverse.

Headline inflation is expected to nudge the 6% outer limit of RBI's policy band in the next 3   quarters. Core inflation, too, has moved past 4% as price pressures broaden. The inflation risk could rise further if the Iran conflict lingers. Keeping a lid on prices at the fuel pump will show up on the fiscal side, adding to the need for monetary contraction. Besides, effects of a deficient monsoon and rise in global plastic prices are yet to play out. Food inflation is not episodic this year and does not permit being looked through in rate-setting decisions.

Credit growth must come off elevated levels for the economy to cool from the latest RBI upward revision. Real interest rates had plunged because of the spike in inflation and RBI's rate cut last December. Indian debt must become attractive to foreign investors as they sell stocks aggressively. The rupee is under pressure on account of India's energy imports as well as capital outflows. A moderately severe interest-rate hiking cycle should address these concerns, too. There is scope for RBI to frontload rate hikes to avoid falling behind the curve, as it did during the previous energy shock brought on by the Ukraine conflict.