MPC minutes show that fight against inflation is far from over

21 Apr 2023 , 10:24 AM

The Monetary Policy announced by the MPC on 06^th April 2023 came as a surprise; even a whiff of fresh air. After hiking rates by 250 bps from 4% to 6.50% between May 2022 and February 2023, the MPC decided to call a halt. However, the RBI was quick to underline that the decision to maintain status quo on rates in April was merely a pause and should not be construed as the end of the rate hike cycle. RBI would continue to use all tools at its disposal to fight inflation and bring it back to the median rate of 4%. However, with repo rates held at 6.5%, the SDF rate stayed at 6.25% and the MSF rate and bank rate also stayed put at 6.75%. The minutes of the MPC meeting were published on 20th April 2023.

After a long gap, there was total consensus among members of the MPC, at least on one side of the debate. All the six members of the MPC unanimously voted to hold rates at 6.50%. However, only 5 members voted in favour of staying focused on the withdrawal of accommodation while Jayanth Varma opposed such a commitment. The RBI decision to hold status quo on rates came at a time when two interesting forces were at play. The global banking crisis had raised apprehensions that the global slowdown could be precipitated. Secondly, the RBI was under pressure from industry bodies to go slow on rate hikes. Higher cost of funds had strained the profit margins of Indian companies and also weakened their solvency ratios. Here is the gist of the discussion of MPC members.

Shashank Bhide suggests watching the cumulative impact of rate hikes

“The key concern on the growth front in the immediate future is the drag caused by the weak external demand conditions. The impact of any adverse weather conditions on Indian agriculture provides additional downside risk to the growth trajectory.”

According to Bhide, there were two key issues to address in the current policy. Firstly, the RBI had hiked rates by 250 basis points between May 2022 and February 2023. It was, therefore, time to sit back and make a dispassionate assessment of the cumulative impact of all these rate hikes on inflation and growth. Secondly, the banking crisis combined with the intense hawkishness of the Fed had raised the probability of recession. 

Bhide was of the view that inflation may continue to remain a challenge due to oil price dynamics, OPEC supply economics and the impact of the erratic weather on Indian agricultural output. However, the time was ripe for a serious relook at growth, although that would not mean ignoring the inflation mandate. For now, growth did present a bigger challenge and a pause in rates was worth the risk.

Ashima Goyal cautions against overshooting policy rates

“There is no logic for overshooting policy rates and then cutting in a country like India where the largest impact of interest rates is on growth. Also, the current account deficit has reduced substantially in Q3 and its financing is no longer a major issue.”

Goyal, along with Varma, had been a strong critic of the ultra-hawkish approach adopted in the last few policies. The status quo decision was clearly in sync with what Goyal has been saying over the last 4 months. According to Goyal, the central banks globally had tightened money adequately and the time was ripe to sit back and watch the impact. Also, in India, growth was too vulnerable to higher rates.

With repo rates already at 6.5%, 10 year bond yields close to 7.5% and inflation set to taper to 5.2% by middle of 2023, the real rates were well above 1%. That gave enough leeway to the central bank to take a pause. However, she has also underlined that in a volatile scenario, this must not be construed as the end of the rate hike cycle in India.

Jayant Varma says 315 bps of effective tightening good enough

“The 315 basis points of effective tightening of the overnight interest rate (from a reverse repo rate of 3.35% to a repo rate of 6.50%) would be quite sufficient to bring inflation under control. Therefore, I vote in favour of keeping the policy rate unchanged in this meeting.”

Varma, as usual, has made some very incisive points. Firstly, he is of the view that if inflation has to react to rates, then it should react with the current 315 bps of effective tightening. Hence, the first step is to be cautious about not overstepping the terminal rates beyond the point that growth is hampered. Varma does believe that OPEC supply and monsoons could be the key drivers of inflation in India in coming months.

Varma has, however, warned that it would be too premature to call off the fight against inflation. Hence, this may not be the end of the tightening cycle. The task may get more complicated considering that oil and monsoons may pose fresh risks, but the RBI may already be close to the ideal terminal rates. That is still a debatable issue.

Rajiv Ranjan sees positive signs of inflation coming down

“Going ahead, assessment of the impact of the cumulative rate hikes will become important especially in view of higher policy transmission in a bank-based economy. Consistent with that assessment, I vote for a pause in rate hikes in this meeting.”

As Rajiv Ranjan puts it poetically, in a dark room it is best to move in small steps. What the RBI has done runs the risk of monetary divergence; but Ranjan feels the risk is worth it. On the inflation front, Rajiv Ranjan has rightly pointed out that not only were there clear signs of inflation tapering, but also the spike in inflation in January and February could be attributed to the cereals effect. With real rates in positive territory, the time was apt to call for a pause on rate hikes, despite inflation not totally in control.

Michael Patra suggests caution on the inflation front

“An ongoing assessment of the macroeconomic outlook must also prepare for a more restrictive monetary stance; should risks to inflation trajectory materialise. The process of getting inflation back to target could turn out to be gradual and uneven.”

Patra made no bones about warning that inflation was still a major challenge; both actual inflation and expected inflation. While voting in favour of the pause on rate hikes, Patra has called for an unambiguous communication that the RBI would be willing to change tack to a hawkish stance, should the inflation monster rear its head again.

RBI Governor wants global banking turmoil to settle 

“The emergence of banking sector turmoil on both sides of the Atlantic and the oil production cut by OPEC-Plus countries have rendered global outlook more uncertain. Global inflation is easing slowly and central banks need to prevent a hard landing at all costs.”

The RBI governor has made two important points. Firstly, the global banking crisis may have added a new dimension to global risk and it could precipitate a global slowdown. Pausing on rate hikes was an attempt to pre-empt such an impact. Secondly, it is time to sit back and let the full impact of the rate hikes sink in. India, being in an economic sweet spot, can actually afford to do that.

The moral of the MPC minutes is that April is a pause; not an end to rate hikes. However, one can infer that rates may be close to the top, if not already at the top. The bigger question is how the RBI handles the situation, if there is a serious impact on growth drivers.