RBI MPC minutes remains cautious about spikes in inflation

23 Oct 2023 , 06:59 AM

Inflation challenge is far from over for India

The Monetary Policy announced by the MPC on 06th October 2023 was along expected lines. Incidentally, October marked the fourth consecutive policy when the repo rates were kept static at 6.5%. The last rate hike was in February 2023 and since then the RBI has held rates steady at the same level, despite the fluctuations in inflation. In between, inflation spiked to 7.44% in July and then gradually tapered to 5.02% in September 2023. However, as the RBI governor, Shaktikanta Das pointed out in his monetary policy statement, “Inflation has been above the targeted 4% for over 4 years now.” Like in the US, the Indian central banks are also concerned that low inflation was inconsistent with the frenetic rates of GDP growth that India was witnessed. The theme of the minutes was that inflation may have receded, but it has surely not gone away. Hence, the RBI would have to be always prepared with a Plan-B in place, should the inflation actually get out of control. 

The RBI had decided way back in February that it could play the “inflation control above all else” game, considering the importance of real GDP growth for an economy like India. The RBI had to worry about the impact of higher rates on the cost of funds for Indian corporates and the risk of investment depreciation for financials and banks. The RBI had to also be cognizant of the fact that a lot depended on the turnaround in the capital investment cycle. India had started seeing green shoots of this capital cycle revival and it could not afford to hike rates beyond a point. Amidst these ground realities, there are a number of factors outside the control of the RBI. Fed has hinted at more hawkishness and that remains a key risk for the RBI. Also, in recent weeks there has been a worsening of the geopolitical situation in West Asia, with possible impact on oil prices. It is in this context that the RBI published the minutes of the October MPC meet on 20th October 2023. Here is a gist of the views of the RBI MPC members as captured in the minutes of the MPC meeting.

1. Shashank Bhide feels Global Risk remains the big X-factor

“Growth momentum is projected to be sustained in FY24 despite the erratic distribution of monsoons and the weak external conditions based on stable domestic demand conditions. The risks regarding the global economic conditions and incomplete transmission of the policy rate actions undertaken are still relevant.”

Shashank Bhide is right when he says that global uncertainty remains the X-Factor. Of course, he was referring to a possible economic slowdown triggered by rate hikes and the spill-over effects of the real estate crisis in China. Both have the potential to substantially crunch global demand for goods and services. Till the global uncertainty remains, Bhide is of the view that static rates with withdrawal of accommodation would be the answer.

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 is yet to reflect fully in the form of lower inflation. More importantly, Bhide feels that there are distinct growth risks implicit in getting overtly hawkish at this point. The much awaited revival of the capital cycle had just started, and needs reasonably low cost of funds.

1. Ashima Goyal wants policy supportive of reviving investment cycle

“The Fed’s rate strategy of (higher for longer) led to US 10-year yields crossing 4.9%. This has triggered fears that US companies will be in trouble as they re-finance low interest loans taken during the pandemic. However, markets can take comfort from the fact that Chinese excess inventories and deflation are reducing manufacturing costs.”

What Goyal has pointed to is a strange dichotomy in global manufacturing. The risk is not about banks having to provide for investment losses in their books amidst rising rates. It is mor about the risk of global corporates trying to refinance their loans, which may have to happen at a much higher rate. However, that would get compensated as the prolonged real estate crisis and the slowdown in China was lowering the input costs of manufacturing  companies globally. 

Goyal has also given an interesting investment perspective in the minutes. According to Goyal, India was seeing a revival in investments after more than 10 years. In 2011 and in 2017, there had been signs of a revival in investments, but the rate hikes had nipped this bounce in the bud. Clearly, the RBI would not want to repeat that mistake and hence prefers to go slow on rate hikes, at a time when the Indian capital cycle is hungry for funds.

1. Jayant Varma agrees with rate action, disagrees with the stand

“The changes in the outlooks for both inflation and growth are quite modest, and the real repo rate is relatively high in India. I, therefore, support the decision to keep repo rate unchanged. In my view, the real interest rate based on projected inflation is high enough to glide inflation towards the target within a reasonable period.”

The gist of Varma’s view is that, going ahead, inflation would manifest in India through intermittent bursts rather than a secular spike. That does not call for higher rates. However, Varma has also pointed out that consumer borrowing in India is relatively benign and hence the side effects on consumer spending would be marginal, at best. If the global economy does slow, it would damage oil prices and so the inflation problem would be addressed.

According to Varma, the current repo rate at 6.5% was high enough to bring inflation to the target, over a period of time. As on previous occasions, Varma agreed with and voted in favour of the status quo on rates, especially considering that the global spike in yields had less to do with the interest rate expectations and more to do with the sell-off in bonds as they were disappointed with the Fed not hiking rates aggressively still. However, like in the past, Varma 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 4 MPC meetings in a row.

1. Rajiv Ranjan wants focus on the rising global troika

“Three global trends need to be closely watched; rising crude oil prices, rising US bond yields, and rising US dollar index. With growth and inflation broadly moving in anticipated direction, monetary policy needs to hold on while earnestly persevering with disinflationary approach and remaining watchful with readiness to act if the situation demands.”

Like on earlier occasions, Rajiv Ranjan again talked about the Goldilocks effect playing out in the Indian economy. It implies that growth has been much better than expected while average inflation has also been lower than expected. However, the troika of rising crude prices, rising US bond yields and rising dollar index remain a major challenge. These 3 factors are outside the control of Indian policy makers and are giving inflationary signals. 

According to Ranjan, the current situation was a mix of favourable domestic tailwinds and global headwinds. That is looking like policy ambivalence. The vote for maintaining rates is from the point of view of defending the domestic advantages that India had built, in a way, insulated from the global economy. The policy stance of withdrawal of accommodation was to help disinflation at a time when the risk of imported inflation was very high. Also, the withdrawal of accommodation was essential to deal the current liquidity surplus in the system and the rupee liquidity being generated by persistent dollar selling by the RBI.

1. Michael Patra believes that price stability still has primacy

“Within the dual mandate given to the MPC by the RBI Act, price stability is accorded primacy. Only when price stability is secured on an enduring basis against all threats, can attention turn to the objective of growth. Without price stability, real GDP growth cannot sustain as the dividends of growth and jobs are wasted by erosion of purchasing power.”

Michael Patra has underlined that the focus of the RBI is still inflation first and the talk about RBI shifting focus to growth was a myth. The difference is that inflation today has become a lot more complex with extraneous factors playing a major role in inflation. For a country like India, where the vulnerable segments of society are often the worst hit by inflation and weak growth, RBI tries to maintain a balance to ensure that the impact is not too steep. That explains why the RBI has kept rates on hold for so long, since the February 2023.

If the India inflation is broken up into domestic inflation and global imported inflation, then it is the domestic inflation that tends to be more cyclical and the global inflation that tends to be more structural. This is a unique problem for the Indian economy due to the predominance of oil imports into India. That is why, Indian monetary policy occasionally appears to favour growth over inflation, which is not actually the case.

1. RBI Governor still focused on 4% inflation target

“Going forward, inflation outlook is beset with uncertainties from domestic weather events, El Nino conditions, global food, and energy price volatility etc. Inflation expectations of households – both three months and a year ahead – have, however, moved together to single digits for the first time since the pandemic, showing consumer confidence.”

The RBI governor has made 3 important points. Firstly, he underlined that going ahead the fight against inflation would be forward looking. However, anticipating inflation will be a lot tougher in an uncertain global environment. Secondly, Das also underlined that the sharp fall in inflation expectations is a sign that the RBI policy of managing inflation expectations had yielding desired results. Thirdly, the strong economy activity has been largely led by a rebound in services sector and a bounce in manufacturing triggered by the government boost to the capital investment cycle. However, these growth triggers cannot be taken for granted and a supportive policy framework was always needed.

The gist of the MPC minutes is that, the RBI is likely to pause on rates for a longer period. For now, there is no clear incentive to cut rates considering the liquidity surplus in the system and the global uncertainty over inflation. As Das has rightly pointed, the RBI continues to be focused on aligning consumer inflation with the 4% target and anchoring the inflation expectations. However, as Das has admitted, a tougher stand on containing inflation cannot be ruled out, if it is about defending monetary policy credibility.