RBI's uneasy pause: The art and science of monetary policy in uncertain times

The Reserve Bank of India’s credit policy meeting minutes are a lesson on how to move in a dark room. Image: Getty Images
 
The latest minutes of the Reserve Bank of India’s credit policy meeting are a lesson on how to move in a dark room. “With tiny steps,” a member of the rate-setting panel notes, because rife with uncertainties on multiple fronts, any shocks arising from the global economy and the monsoon can throw inflation projections out of gear on the home turf. This by and large is the dominant view of the six-member rate setting panel which unanimously voted to hold rates in its previous meeting.
 
But it is an uneasy pause; cautious and hesitant. In an uncanny show of consonance, each member caveated their vote with ifs and buts which signalled loud and clear that inflation—the elephant in the economy—is not under control:  
 
“I believe that a pause in the policy rates is appropriate in this meeting, without any commitments on the subsequent actions except that aligning the inflation rate with the target will remain a policy priority,” said Shashanka Bhide.
 
“Until it is clear that inflation is well on the path to reaching the target, it is necessary to emphasise that this may not be the end of the rate hikes,” agreed Ashima Goyal.
 
“It is clear that the war against inflation has not yet been won, and it would be premature to declare an end to this tightening cycle. There is need for heightened vigilance in the face of the fresh risks,” warned Jayanth Varma.
 
“Let me state that this is a ‘wait and watch’ pause. Not ‘permanent’ as any durable decline in inflation towards the target of 4 per cent is still distant,” noted Rajiv Ranjan.


 
“While I vote for a pause in this meeting, an ongoing assessment of the macroeconomic outlook should inform a preparedness to re-calibrate monetary policy towards a more restrictive stance with consistent actions, should risks to the inflation trajectory materialise and impede its alignment with the target,” asserted Michael Patra, who was most cautious in his outlook for inflation in the February meeting when he stressed on the importance of “timing”.   
 
“This is a tactical pause and not a pivot or a change in policy direction,” summed up RBI Governor Shaktikanta Das.

Also read: Why the Reserve Bank's rate-setting panel is unlikely to press pause
 

The imponderables: Milk, oil, monsoon

Inflation is mentioned at least 114 times in the minutes, and the tone does not suggest that the risks have cooled off. In fact, Varma highlighted that inflationary risks have increased. “Two inflationary risks have come to the fore since the February meeting. The first risk emanates from the announcement of an output cut by OPEC during the weekend just before the MPC meeting. The second risk relates to the monsoon,” he added.
 
CPI inflation moved from 5.7 percent in December to 6.5 percent in January to 6.4 percent in February and 5.7 percent in March. High and sticky core inflation coupled with higher prices of milk, fruits, and cereals weighed on the index.  

“Milk prices may remain firm in the lean summer season on tight demand-supply balance and high fodder costs. The rising uncertainty in international crude oil prices also warrants close monitoring,” said Governor Das.
 
Analysts point out the rise in milk prices constitutes about 6 percent of overall inflation. Consider this: In February headline inflation was pegged at 6.4 percent while milk inflation stood at 9.65 percent. Companies have raised retail milk prices by an average of 12 percent y-o-y. Industry insiders do not expect a respite from price hikes until Diwali.
 
The rise in milk prices is linked to a multitude of factors. The drop in demand during the pandemic led to farmers underfeeding cattle which has impacted dairy yields. Also, fodder prices have soared from 7.14 percent in January 2022 to 29.3 percent in January 2023 as cost of cereals inched upwards.   
 
“The key factors that could adversely affect the inflation trajectory over 2023-24 are climate related, structural demand-supply imbalance in important food items such as milk and volatile crude oil prices,” agreed Rajiv Ranjan, ED, RBI.
 
Bhide reiterated this view. “The weather uncertainty affecting key agricultural prices globally and in the domestic markets, higher fuel and energy prices due to the supply disruptions resulting from geo-political conflicts and policies may lead to spikes in inflation rate and reversal of these shocks also may not be quick,” he cautioned.

Also read: India Inc's limping earnings recovery in March quarter likely to be lopsided
 

The growth conundrum

The six members differed on the growth aspect of the economy. Four of the six members were sceptical of the growth trajectory. Das and Ranjan were optimistic that government capex would sustain growth amidst global challenges. Accordingly, the central bank marginally raised its GDP estimate for FY24 to 6.5 percent from 6.4 percent earlier. The IMF and the World Bank cut their growth forecasts for India recently in view of global headwinds.

Bhide, Varma, and Goyal acknowledged early warning signs of a slowdown and were worried about the impact of weak external demand and the rising concerns of a heat wave and extreme weather conditions. Patra red-flagged tepid consumer spending and capex by private companies as a cause for concern.
 
There is a subtle but noteworthy difference though. The former three felt high interest rates would sacrifice growth, whereas Patra felt that high inflation would compromise durable growth.   

Also read: Scorching Summer May Derail Rural Recovery, Lead To A Spike In Inflation And Interest Rates 
 
Goyal and Varma are wary of overshooting the terminal policy rate. “There is no logic for overshooting policy rates and then cutting in a country such as India where the largest impact of the interest rate is on growth, the relation between expected rupee depreciation and interest rates is weak, many tools are available to reduce excess volatility of the exchange rate and have been successfully used, the current account deficit has reduced and its financing is no longer an issue,” Goyal explained.
 
“On the growth front, early warning signs of a possible slowdown are visible to a greater extent than in February. In the current situation of high inflation, monetary policy does not have the luxury of responding to these growth headwinds. In fact, it is almost axiomatic that monetary action can cool inflation only by suppressing demand. However, policy makers must be vigilant against overshooting the terminal policy rate, and thereby slowing the economy to a greater extent than what is needed to glide inflation to the target,” Varma observed.
 
Patra believes inflation can fritter away growth. “The lessons of experience and empirical evidence show incontrovertibly that inflation ruling above 6 per cent—as it has done through 2022-23—is inimically harmful for growth. This is already showing up in the deceleration of private consumption spending and the moderation in sales growth in the corporate sector which, in turn, is hamstringing new investment,” he opined.
 


Most economists believe inflation is trending southwards, and brokerage firm Nomura forecasts it could fall below 5 percent in the coming month. This would give comfort for a prolonged pause. Some analysts and economists are hopeful of rate cuts in the second half of FY24.
 
“The 4 percent inflation target is not in sight in the near future, and we think the RBI will not want to achieve it at the cost of lower growth. We expect the RBI to keep repo rates unchanged for the rest of 2023 and cut policy rates by 25 basis points in the quarter ending March 2024,” say HSBC’s India economists.
 
Though Barclays does not expect a reversion of the cycle to monetary easing in FY24, it believes that the RBI’s hiking cycle is effectively over. "While the MPC maintained its monetary policy stance of a ‘withdrawal of accommodation’, thus keeping the option of future rate hikes open, we believe the window for them has closed. As such, we no longer expect any further rate hikes from the MPC in FY23-24. We think only a material upside surprise keeping CPI inflation above 6 percent for a long period would lead to another rate action,” say its economists.