ADVERTISEMENT

MPC Minutes Reflect Alarm Over Rising Inflation

MPC members are concerned about persistent inflationary pressures and showed urgency to control it in their out-of-turn meeting.

<div class="paragraphs"><p>RBI Governor Shaktikanta Das at the Reserve Bank of India headquarters in Mumbai. (Photo: Reserve Bank of India/Twitter)</p></div>
RBI Governor Shaktikanta Das at the Reserve Bank of India headquarters in Mumbai. (Photo: Reserve Bank of India/Twitter)

India's Monetary Policy Committee decided to meet out-of-turn and hike rates by 40 basis points to 4.4% as persistent and rising inflation led to a sense of urgency to act, showed minutes of the meeting held between May 2 and 4.

All members voted in favour of the rate hike.

Necessary To Act Through Off-Cycle Meet

Events since the MPC's last meet in April have led to a further deterioration in the geopolitical situation even as domestic inflation became more broad-based warranting immediate remedial measures, Governor Shaktikanta Das said in his statement.

He cited the sharper-than-anticipated rise in headline inflation in March, along with a likely persistence in inflation pressures.

It becomes necessary to act through an off-cycle policy meeting. Waiting for one month till the June MPC would mean losing that much time while war-related inflationary pressures accentuated. Further, it may necessitate a much stronger action in the June MPC which is avoidable."
Shaktikanta Das, Governor, RBI

"As several storms hit together, our monetary policy response should be seen as an important step to steady the ship," Das said.

He said monetary policy actions are aimed at lowering inflation and anchoring inflation expectations, which should help strengthen the medium-term growth prospects of the economy and protect the purchasing power of the weaker sections of society.

Given the highly uncertain situation, the incoming data and information would be constantly monitored to reassess the outlook and take necessary measures, he said.

Monetary Policy Authorities Forced To Do What They Can

"Geopolitical spillovers have thrust upon us a surge in the momentum of inflation we can ill-afford", deputy governor Michael Patra said in his statement.

"Monetary policy authorities are being forced to respond to an elevation in prices brought on by shortages and bottlenecks they can do nothing about since the problem confronting them is not overstimulated demand but insufficient supply," Patra said.

However, in the absence of supply augmenting measures and/or easing of supply bottlenecks, monetary policy authorities will do what they can do – "front-load their actions, compress demand and render the recovery stillborn", he said.

Patra also cautioned that a global stagflation is now becoming a baseline scenario. "The stagflationary shock is global but everywhere it is being exacerbated by country-specific factors in a synchronised way."

The current approach, Patra explained, is of reversing the extraordinary accommodation—in terms of both the policy rate and liquidity—that was undertaken in response to the pandemic. This, he said, is the right approach to his mind.

When it is done, we will have reached a stage of neutral accommodation—in contrast to extraordinary pandemic time accommodation—from where the next stage responses can be calibrated.
Michael Patra, Deputy Governor, RBI

A Lot Of Catching Up To Do

While the MPC rightly prioritised the economic recovery through 2020 and 2021 and delayed normalisation, there is now a lot of catching up to do, said committee member JR Varma.

This means that it is now imperative to front-load the rate action to the extent possible, he said.

It appears to me that more than 100 basis points of rate increases needs to be carried out very soon. My preference therefore is for a 50 basis points increase in the repo rate in this meeting.
Jayanth R Varma, Member, MPC

Varma said he would have favoured a 50-basis-point hike in the repo rate rather than the 40 basis points favored by the committee members.

"Whatever symbolic or psychological benefit there may be from keeping the hike below 50 basis points is outweighed by the simplicity and clarity of moving in round multiples of 25 basis points, he added.

Varma, however, did not dissent saying that there is no mathematical precision in determining the optimal rate hike. He joked that "he was thankful to the remaining members of the committee for not choosing a 37.5-basis-point hike (exactly mid-way between 25 and 50)."

Varma also said the MPC must consider rephrasing its resolution as most analysts interpreted the phrase “remain accommodative” as a stance despite the conscious decision to drop the word “stance”.

I hope that this time around, the MPC’s intent will be more clearly understood, but if that does not happen, the MPC must consider rephrasing this resolution. It would not be wise for the MPC to persist with language that is pedantically correct, but falls short in communicative efficacy.
JR Varma, Member, MPC

Strengthen Credibility Of Monetary Policy 

Though the current price rise is essentially supply-shock driven, it cannot be ignored given its broad-based nature, spillover effects and persistence, which has a risk of unhinging inflation expectations, RBI Executive Director Rajiv Ranjan said.

Thus, at this stage it is necessary to reinstate the primacy of price stability and strengthen the credibility of monetary policy through demonstrable actions, he said.

Though monetary policy may not have a direct influence on shocks such as the global commodity price shocks, it can play an important role in avoiding the generalisation of inflationary pressures, Ranjan said.

If monetary policy decides to see-through these shocks, and especially if they are not transitory, inflation expectations could become unanchored, he cautioned.

Surprise Timing Better To Mitigate Over Reaction

In view of a reasonable recovery and the sharp rise in inflation, which will also raise inflation projections, front-loading of rate hikes is required to prevent the real rate becoming too negative, MPC member Ashima Goyal said. Among risks from negative real interest rates include households buying gold thus aggravating the current account deficit and hurting financial intermediation, she explained.

However, according to Goyal, markets have priced in excessive rate hikes, Goyal said. "Since consumer demand continues to be soft, and inflation is likely to reduce it further, such excessive rate hikes may not be necessary to impose the quantum of output sacrifice required to moderate inflation," she said.

A surprise in timing with an unannounced meeting at the start of the rate hike cycle maybe better to mitigate further over-reaction, Goyal wrote.

Focus On Price Stability

Given the present assessment of the inflation and economic growth conditions, monetary policy measures to break the inflation dynamics have become necessary, MPC member Shashanka Bhide said.

While the impact of such monetary policy measures may affect growth momentum adversely in the short-term, the overall external conditions also require that domestic inflation pressures are contained quickly, he said.