A narrower interest rate differential with the U.S. is unlikely to prompt India's monetary policy committee (MPC) to raise rates, but a rebound in inflation certainly could, three external members of the MPC said in separate interviews.
While internal members of the Reserve Bank of India's (RBI), six-member MPC are widely perceived as being far more hawkish than their colleagues, all three external members have now said sustained inflation could prompt rate hikes.
Domestic markets have been concerned about India being pressured to follow the U.S. Federal Reserve in raising rates to ensure that a too-narrow rate differential does not restrict dollar inflows.
"As growth comes back ... inflows are returning - they are affected more by growth prospects. Moreover, a lower inflation differential makes a lower nominal interest rate differential feasible," said Ashima Goyal, one of the three external members.
"The size of interest-sensitive inflows is not large."
India's MPC has raised key rates by a total of 250 basis points since May 2022 but held steady in April and June, reiterating that the pause was not a pivot and that rates would be raised if warranted.
"In the U.S., inflation is far above their target, the economy is extremely robust and inflationary pressures are more deeply entrenched," said Jayant Varma, a second external member of the MPC.
"The whole purpose of an inflation targeting regime with an independent MPC is to insulate monetary policy from exchange rate considerations," Varma said, adding that the concern was that as inflation expectations decline, the current level of the repo rate would become excessive.
Real interest rate
Though all members felt the real interest rate in the economy - at around 1.5% currently - is high and could be restrictive of growth, they said it will have to be looked at from the perspective of the future inflation trajectory.
"Real interest rate alone is not the concern, it is important to also get inflation to a rate at which we are comfortable," said Shashanka Bhide, the third external member, adding that a positive real rate was essential but "obviously not very high, not 1.5%".
Though annual retail inflation cooled to a more than two-year low of 4.25% in May, firmly within the mandated 2%-6% target band for a third month, all members said upside risks to inflation remain, particularly from a bad monsoon.
"Further rate action is data dependent, it may be warranted if inflation rises and we feel that it is going to be a persistent effect," said Goyal.
"We want to focus on reaching the inflation target (4%)," she added.
Bhide said vulnerabilities from a bad monsoon are lower as compared to five or ten years ago, but sustained high prices of items like cereals is concerning.
"At the moment I think a failure or deficiency in the monsoon would be a concern for us, because as far as prices are concerned, they are sensitive to the expectations of (crop) output."
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