The RBI is likely to opt for a prolonged pause, extending until the middle of next year.

The RBI is likely to opt for a prolonged pause, extending until the middle of next year.

The monetary policy has continued to prioritize maintaining tight liquidity conditions following a pause in April 2023. This emphasis on tight liquidity stems from the potential inflationary impact of consecutive food price shocks. Adverse weather conditions have led to over 50 percent inflation in the CPI food basket, with expectations of it surpassing 60 percent in November, driven by increased vegetable prices, particularly onions.

The RBI has appropriately chosen to overlook food price shocks given the well-behaved core inflation and contained inflation expectations. However, the recurring nature of these shocks increases the risk of price pressures spreading beyond food to non-food sectors. To counter this, the RBI has maintained tight liquidity conditions through Incremental cash reserve ratio (I-CRR) from August to the first week of October, resulting in weighted average call rates remaining close to the marginal standing facility (MSF) rate.

In the October policy, the RBI surprised the market by hinting at the potential use of open market operations (OMO) sales through auctions to tighten liquidity. Despite this, liquidity conditions tightened organically, driven by increased currency leakage in November during the festival season and RBI's forex (FX) intervention. The scope for OMO sales through auctions is limited in the short term, as liquidity conditions are expected to tighten further.