The Reserve Bank of India’s Monetary Policy Committee (MPC) members were unanimous in stressing the need to bring inflation within the central bank’s tolerance band, the minutes of the rate-setting panel’s latest meeting released on June 22 show.
“The time is appropriate to go for a further increase in the policy rate to effectively deal with inflation and inflation expectations,” RBI governor Shakitkanta Das, who heads the six-member panel, said.
“As our policy in recent months has been unambiguously focussed on withdrawal of accommodation, both in terms of liquidity and rates, the change in the wording of stance should be seen as a continuation and fine-tuning of our recent approach,” Das added. “The withdrawal of accommodation, as I see it, would be non-disruptive to the process of recovery and would strengthen our ongoing efforts to combat inflation and anchor inflation expectations.”
The MPC raised the repo rate by 50 basis points on June 8 , almost a month after it had gone for 40 basis point hike in an off-cycle policy meeting to combat rising price pressure. One basis point is one-hundredth of a percentage point.
Retail inflation came in at 7.04 percent in May, easing from a near-eight-year high of 7.79 percent in the previous month. Inflation, however, has remained above the RBI’s medium-term target of 4 percent for 32 consecutive months. More worryingly, it has now spent five months above the 6 percent upper bound of the 2-6 percent tolerance range.
In the latest meeting, RBI raised the inflation forecast by 220 basis points for this financial year to 6.7 percent, while retaining its growth forecast at 7.2 percent.
India’s economy is slowly recovering from the Covid-19 pandemic and subsequent lockdowns. The RBI, like most central banks across the world, is looking to pare the pandemic-era stimulus by raising the repo rate and gradually withdrawing surplus liquidity from the banking system.
‘Direction, not level, of inflation should be watched’
In the minutes released on June 22, internal member Michael Patra said headline inflation levels would remain high across the world for some time, hence, the thing to watch is the direction of inflation, not its level, which will remain elevated for some time in view of the overwhelming shocks.
“If headline inflation starts moving down in the second half of the year, the objective of taking the policy rate above the level of future inflation will be achieved sooner than later, providing space to pause and reconfigure,” Patra said in the minutes.
The RBI’s endeavour should be to bring down inflation into the tolerance band by Jan-March or April-June and progressively align it to the target during the course of FY23, Patra said.
Further, Patra added that the MPC’s objective should be to take the repo rate to a height that is at least above the four quarters ahead forecast of inflation, knowing that monetary policy works with lags.
“Concomitantly, it is important to condition public perceptions and
expectations that growth will be closer to 6 percent than to 7 percent in 2023-24 as a result of monetary tightening,” said Patra.
External member Jayanth Varma said more needed to be done in the MPC’s future meetings to bring the real policy rate to a modestly positive level consistent with the emerging inflation and growth dynamics.
“I believe that the time is therefore ripe for MPC members to start moving towards providing projections of the future path of the policy rate. This would help stabilize long term bond markets and also anchor inflation expectations,” the minutes quoted Verma as saying.
Another member, Ashima Goyal, said at the current stage of recovery, the one-year ahead real rate must not be more negative than -1 percent.
“A fifty or sixty basis point hike would achieve this, while looking through part of the spike in 2022 even as further supply-side movement and clarity on global developments are awaited,” Goyal said. “Such a real interest rate, while not dampening the recovery much, will prevent a possibly inflationary further rise in demand and unsustainable current account deficit. Markets benefit from recovery and so are better able to absorb rate hikes that are in step with the latter.”
Rajiv Ranjan, an internal member, said given that the inflation expectations in India were largely adaptive or backward looking, persistent supply disruptions and the resulting price pressures could get entrenched in higher inflation expectations.
“Since the short-term trade-off between inflation and output worsens under high inflation expectations (the upward shift of the Phillips curve), this would call for front-loaded policy action to rein in inflation expectations,” Ranjan said.
Shashanka Bhide also said that inflationary pressures that intensified since March were expected to remain a concern in FY23 unless the international supply conditions improved quickly. Moderating inflation pressures now was crucial to ensure a stable macroeconomic environment, he said.
The panel is now scheduled to meet in August for its bi-monthly review.