Express View on MPC meet: An extended pause

In line with expectations, the monetary policy committee of the Reserve Bank of India has voted unanimously in its August meeting to keep the policy repo rate unchanged at 6.5 per cent. Alongside, the committee members voted 5-1 to keep the stance unchanged, focusing on the withdrawal of accommodation to ensure that “inflation progressively aligns with the target”. The tone of the RBI Governor’s statement was distinctly hawkish as he emphasised the readiness to act and reaffirmed the policy objective of aligning inflation with the central bank’s target. However, considering that the requirement for a policy response at this juncture is curtailed due to a supply-side induced spurt in food inflation and a moderation in core inflation, it would seem that the MPC is likely to maintain status quo on rates in the near term.

The trajectory of inflation, however, remains unpredictable. In its June policy, the RBI had projected it at 5.2 per cent in the second quarter. In its August meeting, it substantially revised its projection upwards to 6.2 per cent as prices of vegetables have soared in July and August. While this surge is likely to be temporary — the commentary from the RBI does suggest that the central bank believes that vegetable prices will correct in the near term — there remains considerable ambiguity over food prices on account of uncertainty over the distribution of monsoon and impact of El Nino. During such periods, as the RBI Governor has underlined, “supply side interventions” can limit the “severity and duration of such shocks”. On Wednesday, the Union food ministry announced that it was offloading 50 lakh metric tonnes of wheat in the open market in a phased manner. This could have a moderating influence on prices. However, other factors, such as higher crude oil prices, also pose risks to the trajectory of inflation. The central bank has now revised upwards its full year inflation forecast to 5.4 per cent, from 5.1 per cent earlier. Alongside, it has also taken steps to absorb the surplus liquidity generated by the return of the Rs 2,000 notes to the banking system by imposing an incremental cash reserve ratio of 10 per cent.

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On the growth front, the RBI remains optimistic, expecting the economic momentum to continue. The central bank has retained its forecast for GDP growth this year at 6.5 per cent, even as external demand weakens and the cumulative rate hikes of 250 basis points are still working their way through the system. However, considering the uncertainty in the global economy, the central bank must remain vigilant on all fronts. While it has done well to look through this spurt in inflation, it must be cautious. As the governor’s statement also acknowledges, “frequent incidences of recurring food price shocks, however, pose a risk to anchoring of inflation expectations”. The future course of monetary policy will be influenced by how growth and inflation evolve over the coming quarters.