Positive Real Interest Rates

Executives at the Reserve Bank of India (RBI) have rarely been this comfortable when developed nations’ financial markets were in turmoil. Soaring yields on bonds, rising defaults, wobbly financial markets and troubled geopolitics are all around, but few ripples are seen here.

When the Federal Reserve chairman and the European Central Bank president are still guiding for raising interest rates, RBI maintains the status quo monetary policy while providing the central bank’s customary cautionary footnote on remaining vigilant.

At the heart of monetary policy making is prices and the character of that is diverging between developed markets and the emerging markets, especially India, which tracks a consumer price index (CPI) loaded with food articles.

Prices are set to rise more than the target for some more quarters, but the solace is that the RBI’s target of 4% is less than 200 basis points away.

The crisis in India was attributed to persistently high inflation and negative real interest rates that led to investors choosing real estate and gold over financial securities, depressing financial assets. The solution then was to ensure positive real interest rates, where risk-free return is higher than the rate of inflation.

Given that monetary policy actions impact with a lag, the series of hikes since 2022 across the global is beginning to pinch. Price pressures could ease, although the pace may differ across geographies.

The Indian CPI is loaded with farm products and can swing to extremes. Furthermore, there are enough tools in the form of tax rates, price and trade controls to prevent runaway prices.

The rate-setting committee goes by inflation forecast than by past numbers. Even if it bumps up its next fiscal-end forecast by 100 basis points in an extreme case to 5.4%, it would still have room to maintain the status quo for a long time with repo rate at 6.5%.

High global yields and financial stability could keep the central bank on high alert, but positive real rates gives it a long rope to be on pause.