RBI MPC Minutes: Inflation Easing But Still Unacceptably High, Members Reaffirm

India's Monetary Policy Committee minutes reaffirm the continuing concern over high inflation, even as the Reserve Bank of India believes that inflation has peaked.

On the domestic front, though inflation has moderated and plateaued since its recent peak of April 2022, it remains unacceptably and uncomfortably high, RBI Governor Shaktikanta Das said.

The high level of inflation continues to be broad-based with 13 out of 23 CPI sub-groups/groups, comprising close to 60% of the CPI basket, registering more than 6% inflation in June 2022.

Going forward, though there are early indications that inflation might have peaked in April, significant uncertainties remain on account of adverse global spillovers coming from simmering geopolitical tensions, volatile global commodity prices and financial markets, Das cautioned.

While the let-up in global food and industrial metals prices should lower imported inflation, the appreciation of the U.S. dollar could offset some of the gains, he said. Persistently elevated cost of living conditions can engender wage-price spirals, especially as firms regain pricing power.

Sustained high inflation, unless addressed effectively, could result in un-anchoring of inflation expectations and their second order effects, Das said. This necessitates appropriate monetary policy response to prevent upward drift in inflation from the target rate.

The sequence of our policy measures is expected to strengthen monetary policy credibility and anchor inflation expectations. Our actions would continue to be calibrated, measured and nimble depending upon the unfolding dynamics of inflation and economic activity, he said.

All in all, the Indian economy is running a positive growth differential vis-à-vis the rest of the world, Deputy Governor Michael Patra said.

Monetary policy, unseen and unsung, has played a key role in this swivel, he said. The frontloaded and pre-emptive actions so far are already working into inflation expectations of households. Their perception of current inflation as well as their expectations three months and one year ahead have declined appreciably in the latest round of the RBI’s survey.

Although inflation seems to have peaked, it is still unconscionably high. Risks to the trajectory of inflation in the form of currency depreciation, seasonal pressures and the monsoon’s uneven progress could upend the moderation in momentum recently recorded, Patra cautioned.

Even with perfect credibility, monetary policy cannot look through the second-round effects of repeated supply shocks. The inflation target may be breached for a prolonged period. This could unsettle expectations and eventually get reflected in higher inflation.

Higher credibility can reduce–not substitute for–the monetary policy response to second-round effects of repeated supply shocks, he said. By frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target, he explained.

As mentioned in the minutes of the June policy, we need to factor in quicker and improved monetary transmission with the introduction of the external benchmark regime in this tightening cycle while arriving at a terminal rate, Executive Director Rajiv Ranjan said.

As per the baseline projections, inflation is likely to remain above 6% till Q3 FY23. This would require monetary policy to persevere with its exit from accommodation to ensure that frontloaded policy rate hikes dampen inflation expectations, anchor second-round effects and firmly establish our commitment to price stability, Ranjan said.

The frontloading of policy actions is expected to strengthen monetary policy credibility and temper the need for aggressive rate hikes in future.

Inflation is at unacceptably high levels, and the projected trajectory is also above target during the entire forecast horizon, MPC member Jayanth R. Varma said. Economic growth has, on the other hand, proved resilient in the face of an adverse global environment.

"In this situation, there is clearly a need for frontloaded hikes in the policy rate. The choice to my mind is between 50, 60 and 75 basis points."

The logic of frontloading 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, Varma argued.

Weighing against that is the fact that a 75 basis point rate hike is quite unusual (despite a few recent hikes of this magnitude globally in the recent period). 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, he said.

Also, even with a 50 basis point hike this month, the cumulative tightening in the past few months of 140 basis points would make the real interest rate positive based on projected inflation 3-4 quarters ahead.

"On balance, therefore, I do not favour a 75 basis point hike at this juncture," he said. The choice between 50 and 60 basis points is less clear cut.

On the resolution to remain 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", he said.

Because the rate hike in this meeting takes the policy rate above the pre-pandemic level, “withdrawal of accommodation” cannot refer to the withdrawal of the pandemic era accommodation. 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%.

"In my view, such an indication of a terminal repo rate of 6.50% is totally unwarranted in the situation that we are in." It is easy to imagine that a few months from now, the economic data could point to a terminal repo rate that is well below 6.50%, Varma said.

"To focus on one thing implies paying less attention to other things, and I do not think it would be wise to say that the MPC will remain “focused” on withdrawal of accommodation ignoring other considerations."

"I do not wish to record an outright dissent on this resolution because clearly further withdrawal of accommodation is warranted," Varma said. The terminal repo rate may or may not be 6.50%, but it is almost certainly well above 5.40%.

Attempting a soft landing for the economy is important, however. For this, policy rates should not depart far from equilibrium, MPC member Ashima Goyal said.

Since the real rate is now near neutral, though uncertainty and global risks to both growth and inflation remain high, policy has to carefully monitor incoming data and respond to current developments, she said.