August MPC minutes indicate elevated inflation worries

22 Aug 2022 , 05:22 AM

In the recent meeting of the Monetary Policy Committee (MPC) concluded on 05th August, the RBI raised repo rates by another 50 basis points from 4.90% to 5.40%. With the August rate hike, RBI has hiked rates by 140 bps between May and August from 4.00% to 5.40% (now 25 bps above the pre-COVID rate). In addition, RBI also hiked the lower base of SDF (special deposit facility) by 40 bps while the 50 bps CRR hike in May 2022 soaked up liquidity of Rs87,000 crore. RBI has been as aggressive and hawkish as the US Federal, if not more.

In a sense, the RBI has already brought the rates to near-neutral levels and further rate hikes from here could impact GDP growth. However, even as the RBI has been calibrating its next move, the focus on controlling inflation is unmistakeable. One outcome is visible in recent inflation numbers. CPI inflation has come down by 108 bps since May while WPI inflation is down 270 bps since June 2022. All 6 members of the MPC were unanimous about hiking repo rates to 5.40%. However, Jayant Varma objected to usage of 2 contradictory terms “withdrawal of accommodation and supporting growth” in its policy stance. Here is a gist of the minutes of the MPC meeting published on 19th August 2022.

1.      Shashank Bhide highlights the inflation risk perspective

Bhide has pointed to the elevated levels of inflation persuading the MPC to continue with its rate hikes. According to Bhide, while the inflation levels are tapering it is still well above the outer tolerance limit of the RBI of 6%. Inflation has been above the RBI median expected inflation of 4% for more than 3 years now. Bhide expressed concerns that the monsoon shortfall, lower Kharif acreage and the recent changes in the GST could add to the inflation risks to the economy. Elevated inflation remained a major concern.

Bhide pointed out that on the growth front, most of the high frequency indicators have hinted at the growth momentum continuing. Effectively, the higher repo rates have not had any significant impact on the GDP growth levers. In fact, recent data on GST collections, E-Way bills and even non-food credit have indicated momentum in growth continuing. This gives the RBI leeway to focus more on inflation. Bhide voted for a 50 bps rate hike with focus on withdrawal of accommodation.

2.      Ashima Goyal points to resilience of India growth story

While Bhide had justified the rate hike more from an inflation perspective, Goyal has justified the rate hike more from growth perspective. According to Goyal, India had sustained its growth momentum in the last 3 years even in the face of global headwinds like the Chinese lockdown, US Fed hawkishness, Europe slowdown, Russia war etc. She pointed out that despite the recent rate hikes, the real rates were negative on a median basis. This gives room for more hawkishness by the RBI.

According to Goyal, the revised repo rate at 5.40% would take the 10 year bond yields closer to 7.5% and that would just about take the real rates into positive territory. This will ensure that India does not suffer any risk-off capital outflows at a time when the US Fed is also tightening aggressively. Goyal expects GDP growth to pick up further in line with credit growth as India emerges from a prolonged period of deleveraging.

3.      Jayant Varma wants inflation control above all else

Varma has been quite categorical about focusing on inflation control and his ideal choice of rate hike was between 50 bps, 60 bps and 75 bps. Since growth was resilient, Varma feels the entire focus should be on front loading rate hikes to cut down inflation rapidly and brutally. According to Varma, front loading of rate hikes would go a long way in reinforcing the credibility of the RBI effort and also rapidly bring down expected inflation.

However, Varma is less than convinced about how to withdraw accommodation and keep growth intact. He preferred a focus on withdrawing accommodation in absolute terms with no strings attached and that was the only area in which he had raised an objection. According to Varma, as of now the terminal repo rate level is not clear and could even be the pre-2019 repo rate of 6.50%. Varma is affirmative that the terminal rate is above 5.40%.

4.      Rajiv Ranjan talks on stagflation versus recession

According to Rajiv Ranjan, the concerns over the world economy had moved from stagflation to recession and that had triggered a major debate over a soft landing. According to Ranjan, inflation could be a two-way street for the RBI. On the one hand, the global tapering of commodity prices could bring down inflation meaningfully. However, food inflation in India remains a risk due to weak Kharif acreage amidst erratic monsoons.

Ranjan also pointed out that, thanks to the external benchmark lending rate (EBLR), the transmission of rate hikes happens rather quickly. Hence any impact on consumption and inflation should be much faster than it has been in the past.

5.      Michael Patra warns of the risk of a rising dollar

Patra has provided an interesting perspective on inflation. According to Patra, the dollar has recently strengthened by 8.3% and that is resulting in a lot of imported inflation for India. India has been heavily importing crude, coal, coke and gold and in all these cases, the dollar strength is haunting and adding to inflation. According to Patra, apart from monsoons, the biggest risk to inflation in India comes from depreciation of the Indian rupee.

Patra has rightly pointed that the most important thing for the RBI to manage is the inflation expectations of consumers. Affirmative front loading of rate hikes by the RBI results in lowered inflation expectations. Lower the inflation expectations, higher will be the spending and growth levers will be in place. Patra also voted for a 50 bps rate hike and withdrawal of accommodation as outlined in the MPC.

6.      RBI Governor wants to set the cornerstone for long-term growth

The RBI governor, Shaktikanta Das, has admitted that global growth had been sharply downsized by the IMF since the last meeting of the MPC. Das underlined that 60% of items in the CPI inflation basket had inflation of more than 6% showing broad based price increase. Das has also called for the need to anchor inflation expectations by being aggressive on rate hikes. RBI would not relent on its hawkish stance, till medium term inflation gravitated towards the preferred target of 4% mark.

Here are 2 takeaways from the MPC minutes. The entire focus of rate hikes is on managing the inflation expectations. After all, that is the lead indicator for inflation and growth. Secondly, the biggest risk to inflation is from the strong dollar, and that is a factor out of control. As Jayant Varma would have loved to put it, “It is time to either run with the growth hares or hunt with the inflation hounds”. For now, the latter is the preferred option.