MPC minutes highlights member concerns on food inflation

25 Aug 2023 , 09:37 AM

The Monetary Policy announced by the MPC on 10^th August 2023 was largely along expected lines. Like in the April and the June policy, the RBI MPC held rates even in the face of inflation risks. Of course, the actual CPI inflation came in 4 days after the RBI policy statement and it was a real shocker at 7.44%. However, the fact remained that RBI did no hike rates for 3 MPC meetings in succession. That not only puts the monetary policy statement at odds with the objective of inflation control, but also raises risks of monetary divergence with other central banks. Remember, the US Fed, ECB and the Bank of England have not shown any signals of relenting on hawkishness. Somehow, the members were confident that the current rate of repo rates at 6.5% would be sufficient to push inflation lower to the target of 4%. However, these deliberations were held before the CPI inflation data was announced in mid-August by the MOSPI. 

There are several reasons why the RBI opted to hold rates in August 2023, despite inflation risks. The June inflation had only spiked from 4.25% to 4.81%, but the July inflation spiked from 4.81% to an inordinately high 7.44%. Having said that, one cannot miss the concerns that members of the MPC had expressed on food inflation in the light of the monsoons playing truant. The argument, or at least the assumption, was that the spike in inflation would be temporary and would eventually taper once the output came into the mandis. However, as the governor Shaktikanta Das has himself pointed out, there is the gnawing risk of the El Nino effect this year and that could be an X-factor in terms of food output and food inflation. The irony is that in just 2 months the inflation is very close to the previous peak of April 2022 when consumer inflation had touched 7.79%. The last 2 months have effectively negatived most of the anti-inflation efforts of the RBI and that is surely an area of concern expressed by the MPC members in the minutes. Here is a gist of the views of the RBI MPC members as captured in the minutes of the MPC meeting.

Shashank Bhide feels inflation risk captured in inflation projections

“While there is a moderating trend in headline inflation rate, there are upside risks on account of weather uncertainty. Global commodity prices remained low in 2023 relative to 2022. However,  volatility has increased for some agricultural commodities and energy prices have hardened.”

Shashank Bhide is of the view that while inflation is a concern, the inflation is at best likely to be temporary. He is also confident that any likely spike in inflation has already been captured in the RBI MPC hiking the full year inflation estimate by 30 bps and the Q2 inflation estimates by over 100 bps to 6.2%. Hence Bhide is confident that while inflation may be an irritant in macroeconomic terms, its worst case scenario is already captured effectively.

Bhide voted for a status quo on the repo rates and to remain focused on withdrawal of accommodation. According to Bhide, the full impact of the 250 basis points rate hike since May 2022 has not been fully reflected in the form of lower inflation. More importantly, Bhide feels that there are distinct growth risks to getting overtly hawkish at this juncture. Green shoots of growth are just start to be seen and tightening at this point could be counterproductive.

Ashima Goyal says it is time to focus on resistant agriculture

“Agricultural prices must become more resistant to frequent weather shocks. That calls for diversified and resilient vegetable supply chains States can experiment with allowing corporations to diversify agri-product buying via more direct access to farmer organizations. Large food retail chains buying from mandis also aggravates price volatility in India.”

Goyal has dwelt a lot on the finer points of supply chain management, but that is the key missing link. However, the larger message that she has conveyed is that that the rate hikes can always be a reaction to a spike in inflation. At this juncture, India must focus on investing on front end and back-end infrastructure, which could have solved majority of the problems of price movements we got to see in the last couple of months. She has cautioned that more inflation upticks may put pressure on the RBI to hike rates.

Goyal has also voted for a status quo on rates and for a monetary stance focused on gradual withdrawal of liquidity. She has justified the stance on the ground that the money markets were on surplus funds, especially after the cancellation of the Rs2,000 denomination note. Hence liquidity needs to be sucked out of the system. Goyal feels that more than the vagaries of food inflation, it is the evolution of core inflation that is more important and would have to be closely observed.

Jayant Varma calls for stoical approach to inflation management

“It was always too early to declare victory over inflation based on few months data. It now looks like we will have a couple of months of inflation readings above the tolerance band. Monthly gyrations must be seen with equanimity. Just as a couple of low readings do not call for celebration, even a couple of very high readings do not call for panic.”

Jayanth Varma voted for the resolution to hold repo rates at 6.50% but dissented on the monetary stance of withdrawal of accommodation. He has maintained the view that the monetary stance of withdrawal of accommodation was out of sync with the current inflation reality. He expects that the inflation would eventually get regulated automatically by the slowdown in China, which will have a demand depressing effect. Hence future inflation numbers would depend more on that and less on what the regulators do at this juncture. 

According to Varma, the current repo rate at 6.5% was high enough to bring inflation to the target, but adjusting for global factors. As usual, Varma agreed with and voted in favour of the status quo on rates. However, had skipped the vote on monetary stance as the stance did not have much relevance in the light of the RBI holding status quo on rates for 3 MPC meetings in succession.

Rajiv Ranjan talks of the inflation dilemma for the RBI

“Monetary policy can do little about first-round effect of a supply side shock emanating from say vegetables. If monetary policy responds to such a surge in headline inflation, the policy could become excessively tight. However, if these shocks do not go away and become persistent then inflation expectations can become unanchored.”

In the previous MPC minutes, Rajiv Ranjan had spoken at length about the Goldilocks scenario wherein inflation has been coming in lower than expected and growth was better than expected. That could have become unfavourable in this month. Growth still remains robust, but inflation at 7.44% in July is inordinately high. In the previous minutes, Rajiv Ranjan had underlined that for any central bank, it was hard to decide when to stop, and the RBI was no exception to that dilemma. 

In the last few meetings, the 3 representatives of the RBI (including Rajiv Ranjan) had been more hawkish than the other three members. He has underlined in this minutes that inflation ran the risk of spiking and also inflation expectations getting unanchored. What was unsaid by Rajiv Ranjan was that the RBI did not have much more tolerance limit on the inflation front, and action would have to come sooner, rather than later.

Michael Patra has a few cautious words on Inflation 

“While short-term supply demand mismatches lie outside the realm of monetary policy, the commitment to price stability requires the RBI to avoid inflation spillovers. In India, food price flares can permeate through wages, rents, transport costs and, through expectations into core inflation, which can be a lot more intractable than food and fuel inflation.”

Patra has actually put the stance of the RBI in the clearest possible manner. The RBI has been buying time and the combination of low inflation and robust growth had given the RBI the elbow room to experiment. That pause has gone on for 3 MPC meets and that free hand may be coming to an end. He underlined that the RBI has to act when it is expected to act, otherwise it becomes an issue of regulatory credibility. Patra also voted to hold rates and to keep stance as withdrawal of accommodation; but inflation warnings are crystal clear.

RBI Governor still focused on 4% inflation target

“Headline CPI will harden significantly in July-August, driven by vegetable prices. This will rectify with the arrival of fresh crops, but there are risks to food and headline inflation outlook stemming from El Nino conditions, volatile global food prices and skewed monsoon distribution. Hence food and core inflation warrant close monitoring.”

The RBI governor has made two important points. Firstly, he has underlined that going ahead the fight against inflation would be forward looking. Anticipating inflation is going to be a lot tougher. However, he abstained from any guidance. Secondly, Das also underlined that the RBI would look to sustain inflation around 4% on a durable basis. So, the fight against inflation is here to stay.

The gist of the MPC minutes is that, the pause decision may be impacted by the spike in inflation. Like the Fed, the RBI is also positive that the cumulative impact of all the past actions would manifest gradually in the months to come. However, that is still a matter of hope. And the basic rule in policy making is that “Hope makes for a good breakfast, but a bad supper.”