MPC Minutes: Members In A Tug Of War Over An Early Pause

The minutes of the central bank's Monetary Policy Committee's December meeting showed that members remain divided over an early pause in the monetary policy tightening cycle.

While some members cautioned against a premature pause in monetary policy, others were against excessive tightening amid a weakening global growth outlook.

"There is no room for complacency, and the battle against inflation is not over," said Shaktikanta Das, governor of the Reserve Bank of India. This necessitates a constant vigil on prices.

Given the elevated inflation levels, particularly the stickiness of core inflation, more calibrated monetary policy action is required to contain the build-up of underlying inflationary pressures, anchor inflation expectations, and bring inflation closer to the target rate of 4% in the medium term. This would strengthen the medium-term growth prospects of the Indian economy, Das said.

"I am, therefore, of the view that a premature pause in monetary policy action would be a costly policy error at this juncture," Das said.

Given the uncertain outlook, it may engender a situation where we may find ourselves striving to do a catch-up through stronger policy actions in the subsequent meetings to ward-off accentuated inflationary pressures, he added.

The effects of monetary policy actions taken so far, supported by improvements in supply responses, could break the 7% plus drift in average headline inflation and at best contain it in the range of 5–6% over the year ahead, deputy governor Michael Patra noted. Thus, inflation can be expected to remain above target over the next 12 months.

The longer inflation stays at current levels, the greater is the danger of expectations getting unhinged, frittering away the moderation reported in the most recent surveys of households, businesses, and professional forecasters. The risk of inflation eroding purchasing power and weakening consumer spending, especially on discretionary items, is becoming significant.

Inflation expectations may also be stalling private investment in capacity creation, as reflected in corporate performance during the second quarter of 2022–23.

Accordingly, a modest reduction in the size of the policy rate increase in this meeting would provide the opportunity to weigh that assessment carefully. Should the incoming information indicate that the recent small easing of inflation is transient rather than the onset of a durable downturn, the MPC should be prepared to respond appropriately in order to achieve the desired inflation objective.

In essence, the MPC needs to see a decisive decline in inflation over a series of monthly readings before it shifts stance, which would otherwise be premature.

MPC member Jayath R. Varma cited the RBI's $100 inflation forecast. This is about 15–20% higher than the Brent crude futures curve at the time of this meeting, he said.

On the other hand, growth concerns have become more troubling in recent months, both globally and domestically. Economic growth is now extremely fragile and definitely not robust enough to withstand excessive monetary tightening, Varma said. "I believe that the 35 basis point rate hike approved by the majority of the MPC is not warranted in this context of reduced inflationary pressures and heightened growth concerns. I therefore vote against this resolution," he said.

Much of the impact of this large, front-loaded monetary policy action is yet to be felt in the real economy. "I believe that 6.25% itself very likely overshoots the repo rate needed to achieve price stability and poses an unwarranted risk to economic growth."

The majority of the MPC is saying that they intend to tighten even more by withdrawing accommodation. "This stance would be even more damaging to the fragile growth outlook, and I, therefore, vote against this resolution also," Varma said.

After frontloaded rate hikes since May 2022, there is a strong case now to take the foot off the accelerator while keeping a sharp vigil on the inflation trajectory, said RBI executive director Rajiv Ranjan.

The discussion on the terminal rate in monetary policy is clouded by the uncertainty surrounding the strength and direction of growth and inflation impulses, Ranjan said.

In this scenario, the important point to note is that the terminal rate is time-varying and has to be discovered based on incoming data and the evolving situation. With the rate hikes done so far and considering the inflation outlook, it can be said with certainty that real rates have moved decisively towards positive territory, yet one cannot be sure of the same if one uses the realised current inflation argument, which is fast gaining ground under uncertain conditions, he said.