MPC minutes: Uncomfortable inflation level, resilient growth offer space for policy actions, RBI Governor says

India’s inflation has plateaued since its recent peak in April but the print remains “unacceptably and uncomfortably” high, while resilient domestic growth gives space to the central bank for policy actions, the Reserve Bank of India Governor said.

‚ÄúSustained high inflation, unless addressed effectively, could result in unanchoring of inflation expectations and their second order effects,” Shaktikanta Das said in the minutes of the central bank’s monetary policy meeting held earlier this month. “This necessitates appropriate monetary policy response to prevent upward drift in inflation from the target rate.”

Retail inflation in India had eased to 7.01% in June, but the print stayed over the RBI‘s tolerance ceiling of 6% for the sixth consecutive month. Consumer prices in India had surged to an eight-year high at 7.80% in April. The wholesale inflation has been in the double-digit for 15 consecutive months.

At the latest policy review, the central bank had left its inflation forecast unchanged at 6.7% for this fiscal year and said the print is only expected to move within the comfort band in the fourth quarter.

Uncertainty on inflation pressures in the global environment remains significant, MPC Member Shashanka Bhide said in the minutes, adding that prolonged Russia-Ukraine conflict and disruptions in supplies, especially for energy and food commodities are a major source of uncertainty for price trends.

“The direct impact of supply disruptions, even if targeted to some geographies, is quickly transmitted elsewhere to meet the overall demand supply imbalances. Weakening of many currencies against the US dollar also imparts inflationary pressures on the domestic economies of the other countries,” he said.

On Aug. 5, the RBI-led Monetary Policy Committee had increased the repo rate by 50 basis points to 5.4% to take it to the pre-pandemic levels, as it sought to bring down inflation to its comfort band and the move was in line with policy tightening by key central banks.

The MPC members, except for Jayanth R. Varma, had also voted for remaining focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

“This statement confuses more than it clarifies,” Varma said in the minutes.

Withdrawal of accommodation cannot refer to the withdrawal of the pandemic era accommodation, but it can only mean withdrawal of the pre-pandemic accommodation that began with the rate cut from 6.50% to 6.25% in February 2019. “A plain reading of this resolution would then be that the MPC is focused on taking the repo rate back to 6.50%,” he said, adding that such an indication of a terminal repo rate of 6.50% is totally unwarranted in the situation that we are in.

Varma called for front loading policy rate hikes and said the choice for him was between 50, 60 and 75 basis points as inflation remained at unacceptably high levels while growth proved resilient.

“The logic of front loading argues in favour of a 75 basis point hike: it would establish the credibility of monetary policy beyond doubt, would help achieve a faster reduction in the inflation rate, and would hopefully reduce the terminal repo rate consistent with bringing inflation close to the target.”

However, he said a 75 basis point rate hike is quite unusual and in the context of market expectations of a 35-50 basis point hike, such a large hike risks being misinterpreted as a sign of panic, and could be unnecessarily disruptive.

The resolution should be interpreted only as stating that there is a high likelihood of further front-loaded tightening without restricting the freedom of the MPC to respond to the changing environment in a data driven manner, he added.

Deputy Governor Michael Debabrata Patra said the global outlook has become increasingly uncertain and tilted by downside risks. He flagged global growth concerns and said the probability of a recession or hard landing has risen to levels that preceded actual recessions in the past.

The “elephant in the room” is the unrelenting strength of the US dollar which has risen by over 8.3 per cent since March 31, 2022 just to set up a numeraire, he said.

While rupee had plunged to a record low in July and India has seen large outflows of foreign funds, MPC Member Ashima Goyal said FPIs are returning because India has better prospects among emerging markets, and the crash in currency and stock markets that they were waiting for in order to re-enter is proving unlikely.

“Attempting a soft landing for the economy is important, however. For this, policy rates should not depart far from equilibrium. Such an outcome also balances between those who gain from a rise in rates and those who lose from it,” she said.

RBI’s actions would continue to be calibrated, measured and nimble depending upon the unfolding dynamics of inflation and economic activity, Das said.

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